Question

Explain the dividend imputation process conceptually. Highlight the differences between a classical (i.e. double) taxation system and a dividend imputation taxation system.

Answer 1

Dividend imputation is an arrangement in some countries, which, seeks to eliminate the double taxation of cash payouts from a corporation to its shareholders.

Under it, a company passes on credits for tax that it has paid on its profits, to its shareholders at the time of payment of dividends. These ‘imputation credits’ offset the amount of tax that the shareholders have to pay on those dividends, thereby avoiding "double taxation" of dividends.

Under the classical double taxation system, companies pay tax on their income and out of the net income (income less taxes paid) distribute cash dividends to shareholders, which cash dividends are again taxed at the hands of the shareholders. Thus, the same income, to the extent dividends are paid, is taxed twice, first at the hands of the company and second at the hands of the shareholders receiving the dividends.

In contrast, under the dividend imputation system, the company allocates a portion of the taxes paid by it to the shareholders, whereby the shareholders, do not have to pay tax on the dividends received by them, thereby avoiding double taxation of the amount paid as dividends..