John Taylor

The federal government has floated the idea of lowering the corporate tax rate – arguing the present rate of 30% is not internationally competitive.

The rationale is that globalisation makes capital perfectly mobile and the marginal non-resident investor in Australian companies will go where corporate tax rates are lowest.

At the same time, the government’s Re:Think tax discussion paper identifies some problems with Australia’s dividend imputation system (albeit recognising some of its advantages).

Under the present system, franking credits provide little or no benefit to non-resident investors in Australian companies – because the franked portion of a dividend paid to non-residents is exempt from Australian dividend withholding tax but does not generate a tax offset for them.

The relatively high corporate tax rate is said to deter foreign investors while the dividend imputation system does nothing to attract them.

Cutting the corporate tax rate across the board would be very expensive, although the cost may dissipate over time if the rate cut produced greater economic activity.

Importantly, the cut in the rate would apply to all companies, not just those with non-resident shareholders.

The revenue cost would be mitigated by a change back to a classical system of corporate-shareholder taxation – where corporate profits would be taxed twice.

For closely held domestic companies, a cut in the rate would encourage companies to retain profits as would a move away from dividend imputation towards a classical system or other forms of corporate-shareholder taxation.

Again, the revenue cost would be mitigated if we removed the 50% discount on capital gains, but this would also encourage profit retention unless capital gains were taxed more heavily than ordinary gains to compensate for the advantages of deferral.

If the problem lies in having a competitive tax rate for non-resident investors in Australian companies, why not have a solution targeted at those investors?

Why don’t we extend tax offsets on franked dividends to non-resident investors? The technical reason is that, for many resident taxpayers, tax offsets on franked dividends are refundable.

The prospect of giving refundable tax offsets to non-resident shareholders probably does not have a lot of political appeal – but it would be a less expensive way of giving these investors in Australian companies an internationally competitive corporate tax rate.

The extension of franking credits to non-resident shareholders would reduce the effective Australian corporate tax rate for non-resident investors in Australian companies in a targeted way.

Australia presently imposes withholding tax on the unfranked portion of dividends paid to non-resident investors.

Where the non-resident comes from a country with which Australia does not have a double tax treaty (DTA) the rate is 30%. Where the non-resident comes from a country with which Australia has a DTA the rate can vary between 0%, 5% and 15% depending on the level of investment and the particular DTA.

Currently, Australia exempts the franked portion of a dividend from withholding tax.

Where the non-resident shareholder resides in a DTA country, Australia could provide a targeted reduction in the effective Australian corporate tax rate that applied to the non-resident shareholder by imposing withholding tax on the franked portion of the dividend while allowing a proportion of the franking credit to generate a refundable tax offset for the shareholder.

Because of withholding tax rates in DTAs, to produce an even effective Australian corporate tax rate for investors from all DTA countries the proportion of the tax offset allowed would need to fall with the withholding tax rate.

For non DTA countries, we should continue our present policy of exempting the franked portion of the dividend from withholding tax and not allowing tax offsets. Generally we do not have DTAs with very low-taxed countries or with countries that are not significant trading and investment partners.

If the Australian corporate rate remained at 30%, extending tax offsets for franking credits to non-resident shareholders tapering down as the level of withholding tax decreased would reduce their effective Australian corporate tax rate.

For example, to produce a very competitive 15% effective corporate rate for non-resident investors Australia could, while maintaining its corporate rate at 30%, provide a full tax offset of where a 15% withholding tax applied, a two-thirds credit where 5% withholding tax applied and a half credit where a 0% withholding tax applied.

In all cases the effective Australian corporate tax rate for a non-resident shareholder would be a very competitive 15% at a lower revenue cost than under an across-the-board cut in the corporate tax rate and the benefits of dividend imputation would be preserved for resident shareholders.

John Taylor is a professor and head of the school of taxation and business law at UNSW Business School. A version of this post appeared on The Conversation.