In July 1987, Australia introduced a dividend imputation system. It is expected to eliminate the double taxation on dividend distributions. In the dividend imputation regime, a dividend distribution contains both a dividend and a franking credit, and the combination is called a franked dividend. In that system, the income tax paid at the corporate level is recognized as a pre-collection of personal taxes. Consequently, the franked credit can be used to offset tax liability in the hands of the recipient of dividends.

The dividend imputation scope was extended in July 1988 when superannuation became entitled to the franked credit from dividend distributions. The latter change of the dividend imputation system occurred in July 2000 when the dividend recipients can refund the excess of the credit. In that case, implementing the dividend imputation in Australia increases the amount of dividends received by shareholders. Given the benefits, the dividend imputation system increases the attractiveness of dividend distributions relative to capital gains. Consequently, the dividend imputation system increases the value of dividends relative to capital gains.

Unfortunately, the benefits from the dividend imputation differ for each type of shareholder. The full benefits of the dividend imputation will be received by individual domestic residents, superannuation funds, tax-exempt income charities, life insurance companies, and trustees. In their hands, in addition to reducing tax liability, the excess of the tax credit can be refunded. In a similar vein, domestic corporate shareholders also receive the full benefit of the dividend imputation. However, instead of being eligible to refund the unused amount of the tax credit, domestic corporate residents can carry forward the excess of the credit.

On the other hand, the benefit of dividend imputation is limited in the hand of foreign shareholders. In their case, foreign shareholders can only utilize the credit to offset withholding tax in the host country. In case when they receive fully franked dividends, they will be exempted from the withholding tax in Australia. As a consequence of the different benefits received by different types of shareholders, the relative value of dividends compared to capital gains also depends on each type of shareholder. For shareholders who can utilize the benefit of dividend imputation, they will get a higher dividend amount. Consequently, dividends will be valued higher than capital gains. However, for shareholders who receive the limited benefit, dividends can be valued lower than capital gains, depending on the tax rate for those two return streams.

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