[1] Dividend imputation was introduced in Australia in 1987 by the Hawke–Keating Labor Government to create a "level playing field" and stopping the double taxation.
Since 1 July 2000, franking credits have been fully refundable, not just reducing tax liability to zero, and the "holding period rule" has applied.
In 2003, New Zealand companies could elect to join the system for Australian tax they paid.
In 2015/16, designated "small business entities" with an aggregated annual turnover threshold of less than $2 million became eligible for a lower tax rate of 28.5%.
Since 1 July 2016, the tax rate for business entities with aggregated annual turnover of less than $10 million has been 27.5%.
Profits retained by the company or distributed to ineligible shareholders remain taxed at the corporate rate.
[6] Companies decide what proportion of the dividends they pay will have franking credits attached.
A franking credit is a nominal unit of tax paid by companies using dividend imputation.
In Australia and New Zealand the end result is the elimination of double taxation of company profits.
For a company that pays tax on all its income in Australia, the franking proportion is usually 100% (or 1).
Its objective is to prevent traders buying shares on the last cum-dividend date and selling them the following day ex-dividend.
For the holding period rule, parcels of shares bought and sold at different times are reckoned on a "first in, last out" basis.
This prevents a taxpayer buying just before a dividend, selling just after, and asserting it was older shares sold (to try to fulfill the holding period).
For capital gains the shareholder can nominate what parcel was sold from among those bought at different times.
New Zealand companies can apply to join the Australian dividend imputation system (from 2003).
However, it costs the company nothing to attach the maximum amounts of credits it has available, which is the usual practice to benefit eligible shareholders.
It is actually possible for a company to attach more franking credits than it has, but doing so attracts certain tax penalties.
Until 2002 it was permissible for companies to direct the flow of franking credits preferentially to one type of shareholder over another so that each could benefit the most as fits their tax circumstances.
The total of all dividends a private company can be taken to pay under Division 7A is limited to its "distributable surplus" for that income year, which includes the retained earnings plus provisions made for accounting purposes.
This is because every dollar that a company pays in company tax could potentially be claimed by an eligible shareholder as franking credit, and the revenue flowing to the government would ultimately be received only at the shareholder's tax rate.
In turn, this meant that the shareholders received fewer credits along with their dividends, and paid tax on the full value as ordinary income.
When gross company tax is reported by Treasury, it is unclear whether the number generally includes the effect of the corresponding franking credits.
In October 2006, the Committee for Economic Development of Australia released a report, Tax Cuts to Compete, concluding that dividend imputation had proved an inefficient means of reducing Australia's cost of capital.
The report, authored by prominent economist Dr Nicholas Gruen, argued that the elimination of imputation would allow the funding of a substantial corporate tax cut.