Tax-Induced Earnings Management within a Dividend Imputation System

Abstract

This study examines whether, under a full dividend imputation system, companies defer income until tax changes beneficial to shareholders take effect. Using a sample of Australian listed companies, we find that companies manage earnings downwards via discretionary current accruals in the year preceding a reduction in personal income tax rates, and in the year preceding a change in the tax status of superannuation funds, which reverse the first year both changes operate in unison. We also examine whether such earnings management is a function of a company’s ownership structure and dividend payout policy. We find a company’s earnings management varies according to the proportion of shares held by superannuation funds, consistent with superannuation funds, as an investor-type, benefiting most from income deferral. We also find income deferral is more likely for dividend-paying firms, consistent with the deferral of dividends and the deferral of income being alternative ways to exploit shareholder-level tax changes to enhance shareholder wealth. Our results are informative of the likely behavior of companies should recent recommendations for reduced personal tax rates be implemented.