Imputation Tax System Research Articles

The Value of Imputation Tax Credits on Australian Hybrid Securities

ABSTRACTHybrid securities are becoming an increasingly important component of the capital structure of Australian firms. While displaying characteristics of both debt and equity, one principal equity attribute of hybrids is their ability to pay franked dividends. This enables resident domestic investors to claim corporate tax payments as a credit against personal tax obligations under Australia's dividend imputation tax system. This paper estimates a value for the ‘franking credits’ that attach to hybrid securities by examining stock price changes around ex‐dividend dates. We add to the literature that examines the ex‐day price changes of ordinary shares (OS) in that the hybrid securities we examine have high dividend yields and are relatively insensitive to market movements. Therefore the signal‐to‐noise ratio is much higher than for OS. Our analysis reveals that cum‐dividend day prices on hybrid securities do not include any value for franking credits. This result is consistent with the notion that the price‐setting investor in the Australian market is a foreign investor who places no value on franking credits.

Institutional Dividend Clienteles Under an Imputation Tax System

Abstract: Shareholdings for a sample of institutional equity funds, operating under the Australian imputation tax system, show that dividend policy and fund holdings are related. Relative to market benchmarks and ownership levels across firms, institutional funds are overweight in stocks that pay dividends. Among dividend‐paying stocks there is no simple preference for high dividend yields, probably because the highest dividend yields are not sustainable. Instead we find an inverted U relationship between institutional ownership and dividend yield. The tax hypothesis dominates the prudent‐man hypothesis in explaining ownership by institutional clienteles. Institutional funds have a higher ownership in stocks which carry full imputation tax credits compared to stocks which have partial, or zero, imputation tax credits.

Taxation of Cross-Border Dividends in Greece: In Line with EC Law Requirements

Using as a motive the infringement procedure of the European Commission against Greece for discriminatory tax treatment of inbound dividends and the subsequent judgment of the ECJ in Case C-406/07, Commission v. Greece, which formed the causa of a radical legislative reform of the Greek regime governing taxation of dividends, the author conducts, in this article, a detailed examination of the Greek dividend tax rules, under the perspective of Community law requirements in this field. In that respect, the author performs an analysis of the extensive case law of the ECJ on dividend taxation, and draws case law principles which, together with the Parent-Subsidiary Directive provisions, constitute the point of reference of the inquiry undertaken. With the example of the Greek dividend tax systems as a tool, the author displays how exemption, imputation and final withholding tax systems are applied in practice and how EC law affects their function and interaction in cases of crossborder dividend distributions.

Cost of capital equations under the Australian imputation tax system

AbstractSince the introduction of the Australian imputation tax system, there have been problems both in the measurement of the market value of franking (imputation tax) credits and in their application to estimating cash flows and the cost of capital. In the present paper, we provide a convenient and robust resolution to the above problems in the context of an internally consistent set of equations for the cost of capital, asset valuation and the capital asset pricing model (CAPM). The equations apply under both classical and imputation tax systems and under differential taxation of dividends, capital gains and interest. The simple form of the CAPM presented here is shown to encompass more complex versions of the CAPM, which attempt to accommodate the effect of personal taxes. The valuation equations require an estimate of the market value of $1 of the firm's dividends, within which is embedded the market value of the imputation tax credits. Separate estimates of the value of imputation tax credits, or Officer's gamma factor, are not required.

A Measure of the Efficacy of the Australian Imputation Tax System*

We examine the efficacy of the Australian imputation tax system in eliminating the double taxation of dividends. Using Australian Taxation Office data, we find that, on average, 67 per cent of distributed imputation credits were used to reduce personal taxes during 1990–2000, but this has increased to 81 per cent over 2001–2004. Overall, the policy shift to an imputation tax system has resulted in a significant elimination of double taxation. Our results are relevant not only to the ongoing policy debate concerning the efficacy of integration tax systems, but also to equilibrium asset pricing models that require an estimate of the value of imputation credits.

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.

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.

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.

Simultaneous Estimation of the Implied Values of Franked (Tax-Free) Dividends, Required Rates of Return and Growth Rates Using a Modified Residual Income Valuation Model

Do investors price tax rebates on dividends? Since President George W. Bush's proposal to eliminate taxation of dividends at both the corporate and personal tax levels, there is a revival of interest on how dividend, corporate and personal taxes affect the pricing of equities. This study explores a setting, Australia, where corporate and personal tax systems are fully integrated in the form of an imputation tax system to examine the pricing of franked (tax-free) dividends using a valuation approach. A procedure is developed to simultaneously estimate the value of franked dividends, the cost of equity, and growth rates implied by share prices, book values, and analysts' earnings forecasts. The analysis is done on an after corporate tax but before personal tax basis by incorporating tax credits as part of payoffs. The estimation procedure employs a system of two equations that are equivalent price expressions based on different periods of earnings forecasts. Via simple manipulation and rearrangement, the system of equations leads to two (regression) relations with four estimates (two constant terms and two slope coefficients). The four estimates are functions of the implied value of franked dividends, the implied value of required rate of return, and the two implied growth rates based on different periods of earnings forecasts for a portfolio of firms. The estimation procedure is performed on a portfolio of firms followed by I/B/E/S from January 1st 1993 to December 31st 1999. The results show that investors do price the tax rebates with the estimates of a dollar of franked dividends being statistically greater than $1. In the estimation procedure, optimistic bias inherent in earnings forecasts would drive the estimate of market value of franked dividends upwards. Another estimation procedure is performed in a setting without imputation tax credits (i.e., the US) to examine the extent to which investors adjust one-year-ahead earnings downwards, knowing that these forecasts are, on average, optimistically biased. To the degree that forecast biases are comparable across the two countries (i.e., Australia and the US), the optimistic bias in earnings forecasts alone cannot fully explain the estimate of the value of franked dividends being greater than $1.

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.

Establishing bounds on the tax advantage to debt

The partial dismantling of the imputation tax system that commenced in July 1997 once more opens the discussion on the relative tax advantage to debt and its impact on the cost of capital. In this paper we examine the implications of these recent changes for the value of the tax advantage to debt. We analyse the value of debt-related tax shields by computing the individual tax liabilities of 1268 quoted companies that reported during the period 1980–2000 taking account of any tax exhaustion or surplus ACT. We use these estimates to establish an upper bound on the tax advantage to debt. We conclude that even following the 1997 changes in the imputation tax system the probable value for the average current tax advantage to debt in the UK at present is at most about 13% of the value of debt.

Dividend policies in Australia and Japan

This paper presents the findings of a comparative study of dividend policies in Australia and Japan. It examines panel data from the constituent stocks of the ASX 200 Index of the Australian stock market and the Nikkei 225 Index of the Japanese stock market. The evidence that Australia, with an imputation tax system which favors dividends over capital gains, has a significantly higher dividend payout than Japan lends support to the influence of environment on dividend policy. Dividend policies in Australia and Japan are affected by different financial factors. Fixed effects regression models indicate that dividend policies are affected positively by size in Australia and liquidity in Japan, and negatively by risk in Japan only. An industry effect is found to be significant in both countries.

Valuation and Cost of Capital Formulae with Corporate and Personal Taxes: A Synthesis Using the Dempsey Discounted Dividends Model

The paper advances expressions for the firm's valuation and cost of capital as a function of leverage. The framework is arrived at by introducing leverage in Dempsey's (1996, 1998) cost of capital framework and is applicable in the context of both classical and imputation tax systems. The framework reveals that both the historical stability of corporate leverage and the firm's choice of financing structure as revealed by the Pecking Order hypothesis are consistent with a tax-based explanation.

Investor Tax Rationality and the Relationship between Dividend Yields and Equity Returns

Morgan and Thomas (1998) contend that the empirically observed relationship between UK stock returns and dividend yields (subject to an imputation tax system) cannot be reconciled with tax rationality. In response, this present note re-examines the theoretical basis for this conclusion. We conclude that the empirical evidence of market behavior may at present be interpreted generally as consistent with investor tax-based rationality.

Grenzüberschreitende Geschäftstätigkeit und effektive Steuerbelastung nach der deutschen Steuerreform

The principle aims of the German tax reform which will take effect from 2001 on are to encourage investment, to strengthen international competitiveness and to restructure the tax system so that it fits with the principle goals of the Common Market. The German tax reform is an important reform since it replaced the full imputation tax system and introduced a shareholder relief system, reduced the corporate and personal income tax rates and finally broadened the tax base by cutting back depreciation allowances.

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.

Perspective

Firms are more likely to pay dividends with higher payout ratios in an imputation environment. The effects of profitability and earned/contributed capital mix on the decision to pay dividends and dividend payout are weaker for firms following imputation tax system than traditional tax system. Insider ownership is positively related to the decision to pay dividends and dividend payout and this effect does not vary between traditional and imputation tax systems. Firms with higher foreign institutional ownership are less likely to pay dividends and have lower payout ratios. The study demonstrates the significance of the imputation tax system upon dividend policy.

Stock Dividend Announcement Effects in an Imputation Tax Environment

A key question in asset pricing is the extent to which tax effects are passed through market prices or are capitalised in them. New Zealand stock dividends provide a useful window into this debate because of (1) the existence of both taxable and non‐taxable stock dividends, and (2) the particular form of imputation tax system which allows the full pass through of corporate taxes to the investor on the proportion of profits which are distributed either as cash or taxable stock dividends. We present evidence that investors value future tax benefits associated with imputation tax credits.

Valuation and Cost of Capital Formulae with Corporate and Personal Taxes: A Synthesis Using the Dempsey Discounted Dividends Model

This paper advances expressions for the firm's valuation and cost of capital as a function of leverage. The framework is arrived at by introducing leverage in Dempsey's (1996 and 1998) cost of capital framework and is applicable in the context of both classical and imputation tax systems. The framework reveals that both the historical stability of corporate leverage and the firm's choice of financing structure as revealed by the Pecking Order hypothesis are consistent with a tax‐based explanation.