Dividend Imputation Research Articles

Optimal dividend policy, debt policy and the level of investment within a multi-period DCF framework

This paper simultaneously analyses optimal dividend, debt and investment policy within a conventional multi-period DCF framework, and takes account of differential personal taxation over both investors and types of income, the effect of dividends and interest on the level of share issues and hence share issue costs, and the effect of dividends and interest on the level of internally-financed investment. Application of the model to three distinct tax regimes reveals that the value benefit from debt is small at best whilst the value benefit from dividends is substantial even in a regime without dividend imputation.

Foreign Investment and Taxation

The relationship between cross border taxation and free float home bias is examined. This explicitly recognizes that insider shares are unavailable to foreigners. Other important explanations for home bias - information asymmetry, behavioural and governance issues – are controlled when examining the impact of cross border tax variables. In our sample of countries about half (three-quarters) withhold taxes on realized capital gains (dividends) of foreign investors and about half of the mature economies provide imputation of taxes paid on dividend income by domestic corporations. A tax credit variable for foreign taxes paid is constructed and found to be statistically significant in reducing home bias. A foreign tax rate too high to be fully offset by tax credits is found to significantly increase home bias. Dividend imputation is a statistically significant impediment to cross border equity flows. The benefit of investor familiarity with foreign opportunities for reducing home bias is found to be mitigated by higher potential for foreign taxation of capital gains.

The effect of taxes on multinational debt location

We provide new evidence that differences in international tax rates and tax regimes affect multinational firms' debt location decisions. Our sample contains 8287 debt issues from 2437 firms headquartered in 23 different countries with debt-issuing subsidiaries in 59 countries. We analyze firms' marginal decisions of where to issue debt to investigate the influence of a comprehensive set of tax-related effects, including differences in personal and corporate tax rates, tax credit and exemption systems, and bi-lateral cross-country withholding taxes on interest and dividend payments. Our results show that differences in personal and corporate tax rates, the presence of dividend imputation or relief tax systems, the tax treatment of repatriated profits, and inter-country withholding taxes on dividends and interest significantly influence the decision of where to locate debt and the proportion of debt located abroad. Our results are robust to firm and issue specific factors and to the effect of legal regimes, debt market development, and exchange rate risk.

Neutrality of a Dividend Imputation System under the Modigliani–Miller Proposition

In 'The Cost of Capital, Corporation Finance, and the Theory of Investment' (American Economic Review, June 1958, 48(3), pp. 261–97) and 'Corporate Income Taxes and the Cost of Capital: A Correction' (American Economic Review, June 1963, 58(3), pp. 433–43), Modigliani and Miller (M&M 1958, 1963) demonstrated that the value of a firm consists of the present value of uncertain future income and the present value of certain income, and that the tax shield will increase the value of a firm in the presence of tax deductibility of the interest payments on debt. However, often criticized is the double taxation of income received by the stockholders from the firm. In a classical taxation system, the double taxation happens because the income is taxed at a firm’s level first and then at a stockholder’s level when the income is delivered to them. Some countries, such as Australia, Canada, and the UK, have removed the double taxation and adopted a dividend imputation system where the amount of tax charged at the firm’s level will be credited back to the stockholders when they receive cash dividends. The most representative one is the system in which a firm is taxed at the corporate tax rate and such taxes are notionally pooled as franking credits. When cash dividends are paid, an amount equal to the cash dividends times the corporate tax rate will be given back to the stockholders as a tax credit.

Re‐examination of the historical equity risk premium in Australia

AbstractIn light of the ongoing debate over the value of the equity risk premium, its increasing use in the regulatory setting, and the impact of dividend imputation on the premium, this paper presents a timely new look at the historical equity risk premium in Australia, and provides an improved understanding of the historical record. We document concerns about data quality that become increasingly important the further back in time one looks. In particular, there are sufficient question marks over the quality of data prior to 1958 to warrant any estimates based thereon to be treated with caution. Accordingly, we present a new set of estimates of the historical equity risk premium corresponding to periods of increasing data quality but of decreasing sample size. Relative to bonds (bills), the equity premium has averaged 6.3 per cent (6.8 per cent) per annum over 1958–2005, which is a period of relatively good data quality. Together with other results in the paper, the findings reveal a historical estimate that is substantially less than widely cited historical studies would otherwise indicate. We reconcile prior evidence through documenting a dividend adjustment that has typically been overlooked. We also provide estimates that incorporate an adjustment for imputation credits.

Dividend taxation and corporate investment: a comparative study between the classical system and imputation system of dividend taxation in the United States and Australia

In recent times a number of countries have initiated some important tax reforms to eliminate the distortions of double taxation. In this context, Australia adopted a dividend imputation system in 1987, while the US employed the 1986 Tax Reform Act (TRA). The analysis in this paper examines the effects on the level of corporate capital investment, on proxies for corporate tax rates, financial leverage, liquidity, capital intensity and firm size after controlling for the tax reforms. The empirical results provide evidence that: (1) dividend imputation as introduced in Australia is an effective way to reduce the distortions caused by the traditional system of taxation. (2) Compared with the TRA, dividend imputation has been better able to positively stimulate corporate capital investment. (3) TRA effect on corporate investment is more pronounced in the US for firms having a net operating loss. (4) Individual tax rates play a role in corporate investment decisions in both the US and Australia.

Taxes and dividend policy under alternative tax regimes

This paper examines changes in corporate dividend policy around the introduction of a dividend imputation tax system. This represented a significant change to the Australian tax framework and allows us to test the effect of differential taxation on corporate dividend policy. Consistent with the tax preference for the distribution of dividends, we find dividend initiations, all dividend payout measures and dividend reinvestment plans increased with the introduction of dividend imputation. Similarly we find that gross dividend payouts are more volatile under dividend imputation. Finally, we find that the increase in dividend payout and initiations differs across firms. In particular, we find that the higher the level of available franking tax credits the higher the firm's gross dividend payout and the more likely the firm is to initiate a dividend.

A Re-Examination of the Historical Equity Risk Premium in Australia

In light of the ongoing debate over the value of the equity risk premium, its increasing use in the regulatory setting, and the impact of dividend imputation on the premium, this paper presents a timely new look at the historical equity risk premium in Australia, and provides an improved understanding of the historical record. We document concerns about data quality that become increasingly important the further back in time one looks. In particular, there are sufficient question marks over the quality of data prior to 1958 to warrant any estimates based thereon to be treated with caution. Accordingly, we present a new set of estimates of the historical equity risk premium corresponding to periods of increasing data quality but of decreasing sample size. Relative to bonds (bills), the equity premium has averaged 6.3 per cent (6.8 per cent) per annum over 1958-2005, which is a period of relatively good data quality. Together with other results in the paper, the findings reveal a historical estimate that is substantially less than widely cited historical studies would otherwise indicate. We reconcile prior evidence through documenting a dividend adjustment that has typically been overlooked. We also provide estimates that incorporate an adjustment for imputation credits.

Relationship between franking credits and the market risk premium

In a dividend imputation tax system, equity investors have three potential sources of return: dividends, capital gains and franking (tax) credits. However, the standard procedures for estimating the market risk premium (MRP) for use in the capital asset pricing model, ignore the value of franking credits. Officer (1994) notes that if franking credits do affect the corporate cost of capital, their value must be added to the standard estimates of MRP. In the present paper, we explicitly derive the relationship between the value of franking credits (gamma) and the MRP. We show that the standard parameter estimates that have been adopted in practice (especially by Australian regulators) violate this deterministic mathematical relationship. We also show how information on dividend yields and effective tax rates bounds the values that can be reasonably used for gamma and the MRP. We make recommendations for how estimates of the MRP should be adjusted to reflect the value of franking credits in an internally consistent manner.

Market Arbitrage of Cash Dividends and Franking Credits*

Since 1986, dividend imputation has influenced the ex‐dividend day behaviour of Australian share prices. This paper explores the effects of dividend imputation on ex‐dividend share price drop‐off from its inception until mid‐2004, with particular attention paid to the differential effects of cash dividends and franking credits. We also explore the effects of the six major legislative amendments to the dividend imputation system that were introduced over the sample period. Only the most recent tax change, which provided full income rebates for unused franking credits, appears to have caused the market to put a statistically significant value on franking credits.

Capital Structure Decisions Under Classical and Imputation Tax Systems: A Natural Test for Tax Effects in Australia

The paper investigates determinants of capital structure, focusing on tax incentives for debt. The paper makes use of a panel of Australian firms in two tax regimes: a classical regime, and a dividend imputation regime. An important feature is the identification of the economic model using Bayesian selection methods. This methodology offers a new way of examining and assessing interactions between variables where there are competing explanations, noisy data and no unifying theory. As hypothesized, the results demonstrate a significant tax coefficient during the classical era and an insignificant tax coefficient in the imputation era. Risk and signalling variables, represented by firm size, Z-score, operating risk and asset base are also found to help explain capital structure choice.

Dividend Imputation Systems in Industrialized Countries: An Examination of Relative Tax Burdens

Abstract Dividend taxation has been a controversial issue especially since the enactment of the 2003 U.S. legislation entitled “Jobs and Growth Tax Relief Reconciliation Act” (JGTRRA). This paper presents taxonomy of dividend tax systems and illustrates dividend relief practices in the OECD (Organization for Economic Cooperation and Development) countries. None of the OECD countries follow the conduit (i.e., full imputation) system, and the classical system (where double taxation of dividends occurs) prevailed only in one country (Ireland) other than U.S. in 2003. Dividend imputation in most of the OECD countries is only partial and takes place at the shareholder level in the form of tax credit or split rate. The paper also demonstrates a method to compute the effective tax rates (corporate plus individual taxes) on dividends, and presents such rates for the OECD countries. In comparison with the average dividends tax rate of 39.6% in other OECD countries, the U.S. had a rate of 60.7%, which JGTRRA has brought down to 44.8%.

The value of dividend imputation tax credits in Australia

A dividend imputation tax system provides shareholders with a credit (for corporate tax paid) that can be used to offset personal tax on dividend income. This paper shows how to infer the value of imputation tax credits from the prices of derivative securities that are unique to Australian retail markets. We also test whether a tax law amendment that was designed to prevent the trading of imputation credits affected their economic value. Before the amendment, tax credits were worth up to 50% of face value in large, high-yielding companies, but subsequently it is difficult to detect any value at all.

Taxes and Dividend Policy under Alternative Tax Regimes

This paper examines changes in corporate dividend policy around the introduction of a dividend imputation tax system. This represented a significant change to the Australian tax framework and allows us to test the effect of differential taxation on corporate dividend policy. Consistent with the tax preference for the distribution of dividends, we find dividend initiations, all dividend payout measures and dividend reinvestment plans increased with the introduction of dividend imputation. Similarly we find that gross dividend payouts are more volatile under dividend imputation. Finally, we find that the increase in dividend payout and initiations differs across firms. In particular, we find that the higher the level of available franking tax credits the higher the firm's gross dividend payout and the more likely the firm is to initiate a dividend.

Dividend Imputation and Shareholder Wealth: The Case of New Zealand

On April 1, 1988, New Zealand stopped the double taxation of dividends by implementing a full dividend imputation program. Because many believed that the tax advantage of debt had led to more highly leveraged firms subject to greater financial risk than was socially optimal, it was hoped the removal of incentives to finance with debt would result in a more efficient allocation of capital. The empirical results suggest that the shareholder wealth gain from dividend imputation was more than offset in firms with large debt levels. Moreover, an examination of debt ratios indicates debt levels declined in the post–imputation period.

Capital Structure Choices and Taxes: Evidence from the Australian Dividend Imputation Tax System

The introduction in 1987 of a dividend imputation tax system in Australia represented a significant change to the tax framework. To the extent that tax incentives influence the use of debt financing, changes in tax laws that alter these incentives will lead to changes in corporate capital structures. This paper examines the changes in corporate capital structure around the introduction of a dividend imputation tax system. The introduction of dividend imputation provides an incentive for firms to (a) reduce the level of debt financing utilized where this incentive varies across firms depending on the firm’s effective corporate tax rate, and (b) increase the level of external equity financing. The results present evidence consistent with these incentives.

Strategies and dividend imputation: the effect of foreign and domestic ownership on average effective tax rates

This study examines how dividend imputation affects the incentive of New Zealand firms to minimize tax. By effectively eliminating double taxation on company income, imputation reduces firms’ incentives to engage in costly tax minimization strategies. Before September 1993, resident and nonresident shareholders were treated differently under New Zealand’s imputation system. Because imputation credits cannot be passed to shareholders unless dividends are paid, we expect firms to pursue different tax paying strategies depending on their level of foreign ownership and their dividend payout ratios. After September 1993 when imputation credits were extended to nonresident portfolio shareholders, we expect that firms with high foreign ownership and high dividend payouts would have less incentive to minimize tax. Our results provide some support for these expectations.

Beta and Return: Implications of Australia's Dividend Imputation Tax System

US studies have consistently reported that the relationship between beta and return is less steeply sloped than that implied by the simple CAPM. The introduction of a dividend imputation tax system in Australia and other tax law differences suggest the relationship between beta and return may be more steeply sloped in this country. Empirical evidence subsequent to the introduction of the dividend imputation tax system in July 1987 supports this hypothesis. Further, it is found that no such change occurs in the US market over this time period, which strengthens the conclusion that the finding is tax-driven.

Capital Investment Effects of Dividend Imputation

We examine the effects of dividend imputation on corporate capital investment in New Zealand and Australia. The empirical findings indicate that: (1) dividend imputation stimulated corporate capital investment in both countries; (2) the positive impact of dividend imputation on capital investment overshadowed any negative effects arising from the new capital gains tax imposed in Australia; and (3) the dividend imputation effects on capital investment are most pronounced for highdividend-paying firms. In summary, we demonstrate the positive impact of dividend imputation on corporate capital investment. Our findings support the conclusions of the U.S. Treasury that the “traditional” double tax on corporate distributions increases the cost of equity capital to the corporate sector and creates a bias against investment by the corporate sector.

Tax Strategies and Dividend Imputation: The Effect of Foreign and Domestic Ownership on Average Effective Tax Rates

This study examines how dividend imputation affects the incentive of New Zealand firms to minimise tax. By effectively eliminating double taxation on company income, imputation reduces firms' incentives to engage in costly tax minimisation strategies. Before September 1993, resident and non-resident shareholders were treated differently under New Zealand's imputation system. Because imputation credits cannot be passed to shareholders unless dividends are paid, we expect firms to pursue different tax paying strategies depending on their level of foreign ownership and their dividend payout ratios. After September 1993 when imputation credits were extended to non-resident portfolio shareholders, we expect that firms with high foreign ownership and high dividend payouts would have less incentive to minimise tax. Our results provide some support for these expectations.