How the Dividend Imputation Account System Works

The imputation account system is part of the dividend imputation framework. It is designed to avoid double taxation — that is, taxation at both the company and shareholder levels on the same profit.

For example, suppose Company A makes a profit of $1,000. At a corporate tax rate of 28%, it pays $280 in income tax. The remaining $720 is then distributed to shareholders as a dividend.

Now, this $720 becomes taxable income for the shareholder. However, since the company has already paid tax on the full $1,000, the shareholder is allowed to report a gross dividend of $1,000 in their tax return and claim a tax credit of $280. Depending on their personal tax rate, the shareholder will either pay the difference or receive a refund of the excess tax paid.

This, in a nutshell, is how the imputation credit system works.

Now, let’s explore how this system operates in other countries:

• New Zealand: The system is referred to as imputation credits. It is fully integrated — shareholders receive tax credits for the tax the company has already paid on their behalf.

• Australia: A similar system exists, known as franking credits. These credits are passed on with dividends and function much like New Zealand’s imputation credits.

• Canada: The system is called the dividend gross-up and tax credit system, and it also works similarly — shareholders gross up the dividend and receive a tax credit.

• Singapore and the United Kingdom: These countries used to have imputation systems, but they were abolished — in 1999 for the UK and 2003 for Singapore. They now operate under different dividend tax regimes.

• United States: The U.S. does not have an imputation system. Company profits are taxed at the corporate level, and dividends are taxed again at the shareholder level — albeit at a lower tax rate. While this system is simpler from an administrative standpoint (no tracking of credits), it does result in some level of double taxation.

• Japan: Japan also does not offer imputation credits. However, to reduce double taxation, dividends are taxed at a lower rate at the shareholder level.

So, which system is better?

Should dividends come with tax credits, or should recipients simply pay tax at a lower rate?

Let’s revisit our earlier example:

A $1,000 profit is taxed at 28%, and $280 is paid by the company. The remaining $720 is distributed to the shareholder. That $280 of tax paid is passed on as a credit.

• If the recipient is in a higher tax bracket, they pay the difference.

• If the recipient is in a lower tax bracket, they may receive a refund or offset the credit elsewhere.

In summary, systems that offer tax credits — such as the imputation credit system — are generally more equitable. They allow shareholders in lower income brackets to benefit from tax already paid at the company level. In contrast, systems without imputation may reduce the administrative burden but can unfairly tax income twice.