Question

The imputation system encourages payment of high dividend. Companies that pay significant dividend may be left short of cash. Comment on this statement.

Answer 1

Dividend Imputation:

Dividend Imputation system decreases or eliminates taxes on dividend income on the grounds that corporates have already paid taxes on the income attributed to equity shareholders as dividends.

In classical system, The residual income after tax of the company will get distributed to the shareholders and after receipt of the dividend, this income will again be taxed in the hands of the shareholders. This leads to double taxation of the same income. To eliminate this issue, dividend imputation system was adopted, Where the individual receiving the dividend will receive the tax credit. This solves the problem of double taxation.

If the income is taxed in the classical manner (double taxation), company will not want to pay more dividends because the dividend will be again taxed and the benifit received by the shareholders will be less. And with the imputation system, income is taxed only once and so, benifit to the shareholders is more as compared to the earlier.

Now, income after taxes of a company is either paid out to the owners (shareholders) or is retained. Part of the income which is retained acts as a cushion for the company. It helps a company to have appropiate liquidity position. This retained earnings is used by company against any unwanted events or for investment in new projects.

If the company pays significant dividends, without retaining adequate earnings, it won't have a cushion. And in case of an unwanted event, Company will not have liquid assets i.e. the company will be left out of cash.

Conclusion:

A company needs to pay adequate amount of dividends to its shareholders, maintaining certain level of liquid funds(cash), for any future need of the company.