The objective of the dividend imputation system is to collect tax on distributed income at the shareholder's tax rate,[3] in order to eliminate double taxation of company profits, once at the corporate level and again on distribution as a dividend to shareholders.
Others (Singapore, for example) eliminate double taxation in a different way, by not taxing dividends in the hands of the shareholder and only at the company level.
The Australian tax system allows companies to determine the proportion of franking credits to attach to the dividends paid.
A franking credit is a nominal unit of tax paid by companies using dividend imputation.
In Australia and New Zealand the result is the elimination of double taxation of company profits.
Dividend imputation was introduced in 1987, one of a number of tax reforms by the Hawke–Keating Labor Government.
In 2003, New Zealand companies could elect to join the system for Australian tax they paid.
A shareholder's taxable income is grossed up to include the value of the company tax deemed to have been prepaid on the dividend.
Profits retained by the company or distributed to ineligible shareholders remain taxed at the corporate rate.
For example, an individual at that time paying no tax would get nothing back, they merely kept the cash part of the dividend received.
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.
The company tax rate has changed a few times since the introduction of dividend imputation.
But it costs the company nothing to do so, and the credits will benefit eligible shareholders, so it is usual to attach the maximum available.
It's actually possible for a company to attach more than it has, but doing so attracts tax penalties that mean this is not worthwhile.
In the past it was permissible for corporations to direct the flow of franking credits preferentially to one type of shareholder over another so that each may benefit the most as fits their tax circumstances.
(There are exceptions which include profits retained by the company that are never paid as dividends, and payments to international investors.)
When gross company tax is reported by Treasury, it is unclear whether the number generally includes the effect of the corresponding franking credits.
Where the imputation credits exceed the actual tax payable on the grossed up income, the revenues office will refund the remainder.
The tax credit was abolished as of 6 April 2016 and replaced with a tax-free dividend allowance of £5,000 (2017/2018).