Australia’s company & shareholder tax system:

Options for fiscally sustainable reform

Joint work by David Ingles, Chris Murphy, Miranda Stewart

Professor Miranda Stewart , Director, Tax and Transfer Policy InstituteCrawford School of Public Policy, Australian National Universitymiranda.stewart@anu.edu.au

13 July 2017

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Large and very large companies pay most

company tax in Australia (2014-15)

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Size Companies Net tax $m %

Loss 1,567 5 0%

Nil 125,936 52 0%

Micro 706,860 8,184 12%

Small 61,173 7,329 11%

Medium 16,497 9,180 13%

Large 1,345 3,418 5%

Very large 1,130 40,251 59%

Total 914,508 68,420 100%

Source-based corporate income tax is

important for Australia

• Net capital importer

• Resource-rich exporter; these sectors earn rents

– Mineral resources

– Agriculture, etc

– Education, financial services

• Relatively small population for consumption

(although rich)

• Current system is source-based

• Consistent with international tax norms

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Corporate-Shareholder Imputation System

• Since 1987 (company tax rate then was the same

as top individual tax rate)

• Dividends paid to shareholder – Include in shareholder assessable income (“gross up”)

– Tax applies at individual marginal tax rate

• Imputation tax credit to shareholder, dividend

“franked”– Out of “tax-paid” franking account kept by company (carry forward

unused credits indefinitely)

– Distribute franking credit, reduce shareholder tax on dividend by

amount of credit

Policy of imputation system

• One level of tax on corporate profits

– Assumes company tax is economically borne by shareholders

• Financing neutrality: Equalise debt and equity finance

• But cross-border is a ‘classical’ system

– No imputation for foreign shareholders

– 30% company tax on dividends paid offshore

– Interest paid offshore is deductible at 30% rate (subject to thin

capitalisation) and may have zero or low (10%) interest

withholding tax

• Foreign debt financing tax-favoured over equity financing

– Base erosion

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Imputation for Australian

resident individual shareholder

Ausco

Jo

Australian source profits

Franked dividend$70

Company tax paid at 30% rate

Personal tax at 45% rate; franking credit of $30

$100(30)$70

$70

+ 30

$100

Tax = $45, less tax credit of $30

Tax owed = $15

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Imputation credit refund for low-rate resident

shareholders

Ausco

Fred

Australian source profits

Franked dividend$70

Company tax paid at 30% rate

Personal tax at 19% rate; franking offset

$100(30)$70

$70+ 30$100

Tax = $19, less tax credit of $30

Tax refund = $11

Refundable credits were introduced in 2001 (partly for retirement funds

to be able to use them: taxed at 15% rate)

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Ausco

Parent Co

Australian source profits

Franked dividend $70

No dividend withholding tax

Company tax $30 paid at 30% rate

No franking credit

$100(30)$70

Foreign tax may apply at F tax rate; likely no tax by participation exemption, or foreign tax credit

Australian company tax operates as a final

30% tax on nonresident investors

Total tax paid = $30

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Ausco

Parent Co

Australian source profits

Interest of $70

WHT ($7)

Interest withholding tax likely 10% or 0%

Company tax of $9paid at 30% rate

$100 profits(70) interest deduction$30 net profit

($9) Tax 30%

Foreign tax may apply at F tax rate; but likely in a tax haven so low tax

Debt capital is cheaper after-tax than equity for

Australian companies with foreign investors

$63

Or Ausco will gross up to $70 for interest WHT

Total tax paid = $15

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Chevron (2016) related party debt

Dividend imputation in international context

• Debate about effects of imputation

• Closed economy view– Dividend imputation ensures one level of tax on

shareholders/investors

– Company tax is just a ‘withholding tax’ on shareholders

– Relevant tax for individual investors is the personal income tax

– Equalises return on debt and equity investment

– Removes bias to retained earnings; increases dividend payouts

– Theory suggests imputation credit is fully priced into shares

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Australia dividend payout ratio

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Source: Ainsworth et al (2015) https://finsia.com/insights/news/news-article/2016/04/14/jassa-the-impact-of-dividend-

imputation-on-share-prices-the-cost-of-capital-and-corporate-behaviour

Dividend imputation in international context

• ‘Small open economy’ view– Cost of capital is set by the marginal foreign investor

– Who is indifferent to dividend imputation credit and responds only to company tax rate/debt deduction

– Company tax discourages investment, requiring higher rate of return

– Suggests incidence of company tax is on domestic factors (labour/wages…)

– On this view: dividend imputation credit is a subsidy ‘free kick’ to domestic investors

(Treasury; Gruen; CGE modelling by Murphy et al 2017)

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Options for corporate tax base and rate reform• Remove dividend imputation

• ACE or ACC (allowance for corporate capital/equity)

Substantial fiscal cost unless constrained in some way

• Comprehensive business income tax (CBIT)

A CBIT of 25% (with taxation of financial institutions) would be

revenue-neutral.

• Hybrid systems of various kinds

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Key features of different corporate tax

bases (by deductions, x-border)Deductions CBIT standard ACE/ACC Cash flow GST/VAT

(compare)

Wages X X X X

Investment X X

Depreciation X X X

Debt X X

Equity X

Source/

destination

Source Source Source Either Destination

Comprehensive business income tax

(CBIT)

• Removes debt vs equity distortion by making neither deductible

• Aims to remove ability to shift profits out by shifting debt in

• broadens base: can fund rate cut

Pragmatic compromise could be combined CBIT/rent tax system:

• aims to removes debt vs equity distortion

• reduce taxation of capital investment, while increasing taxation of

rents

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Some complications

Cash flow, ACC and CBIT face issues in taxing financial services

(because interest flows are not in the base). Some options are:

• use ACE

• use cash flow extended to include all interest-bearing assets and

liabilities (R+F base)

• use cash flow or CBIT extended to include loans and deposits only

What should the rate of return for ACC be?

• ACE and ACC neutrality depends on choosing “correct” returns for

equity (ACE) and equity-debt combined (ACC)

• A common suggestion is to use the corporate bond rate because

the allowed returns represent interest liabilities of a credit-worthy

government

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Budget cost and funding the tax cut

• Budget estimates direct cost of tax cut before behavioural responses

• Static (long-term) CGE modelling of consumer welfare and budget cost/gain

• Effect of behavioural responses? (boost to economy and reduced profit shifting) – estimate that provide self-funding of about half the fiscal cost -such responses included under “dynamic scoring” (e.g. US CBO)

Funding options:

• (standard modelling assumption: lump sum tax)

• bracket creep

• company tax reform (base broadening)

• GST increase

• spending cuts

• other?

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Thanks!

• Questions

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