Commentary | 09 April 2015

Encourage investment by levelling the imputation playing field

Encourage investment by levelling the imputation playing field

Stephen Grenville 

The Australian Financial Review

9 April 2015

Click here for the online text

  • Stephen Grenville

Encourage investment by levelling the imputation playing field

Stephen Grenville 

The Australian Financial Review

9 April 2015

Click here for the online text

  • Stephen Grenville

Executive Summary

A clear message comes out of the Treasury's tax discussion paper. Because our company tax rate of 30 per cent is higher than that of many other countries, we should reduce it so that we are "competitive" in attracting foreign investment. But this message ignores another issue covered in the report - imputation.

Imputation was introduced in 1987 specifically to end double taxation of dividends for Australian shareholders. This is conceptually the first-best answer: the tax system ignores the legal fiction of the corporation and taxes income only once. It also avoids tax distortions between equity and debt. It encourages companies to distribute their profits to shareholders.

Of course, this gives incentive to companies with Australian shareholders to invest here rather than overseas. Company managers recognise that their investment decisions should be guided by the return to shareholders after all taxes (including the shareholders' income tax) are paid. This incentive to invest at home arises not from a fault in the Australian system, but from the distortionary double taxation embodied in foreign tax regimes.

But don't we want to attract foreign investment to this country? The short answer should be that we want to offer foreigners the same tax environment that we offer to domestic shareholders.

The Australian shareholders pay tax at their personal rate on their dividend income, so why shouldn't the foreigners make a similar contribution for the opportunity of making profits here, thanks to the services and favourable environment offered to them in Australia? We don't want foreign companies to be disadvantaged, but nor do we want to offer them a better deal than our domestic shareholders have. With this in mind, to charge the foreigners 30 per cent tax seems eminently reasonable.

Some foreign companies will take their investment to a low-tax jurisdiction. Good luck to them. We don't want to artificially encourage their activities in Australia any more than we want to offer any other form of subsidy to foreigners. If we want to subsidise investment, let's do it for everyone.

Of course, tax in a globalised world is a complex mess. The low-tax arrangements of Google, Amazon and Apple illustrate the problem of a tax system conceived in the 19th century, when it made sense to base company tax on where products were made. Now, it makes more sense to attribute profit to the country in which these types of goods are sold, where profits accrue because these goods are protected by the intellectual property laws of that country.

This issue - "base erosion and profit shifting" - is a priority topic for the Organisation for Economic Co-operation and Development. Whatever the answer, lowering the Australian company tax rate won't fix this.

Competing with Singapore and Ireland on company tax rates is misguided. A couple of per cent off our company tax rate isn't going to get us anywhere near these countries, which have set their rates to attract profit-shifting tax minimisation. This ploy certainly needs correction but it requires internationally concerted action.

The discussion paper makes much of the size of the Australian corporate tax take: about 20 per cent of total tax, or more than twice the OECD average. But the proper comparison of corporate tax revenue would net out imputation against the gross corporate tax receipts. This would reduce the net corporate revenue to a figure comparable with overseas tax regimes.

Then there is the further distortion from those Australians who have arranged their personal affairs so as to be treated as if they are companies. The tax report recognises this problem but doesn't offer an estimate on the loss of revenue. A reduction in company tax would offer an even greater differential between the company tax rate and the top marginal income tax. Why would we want to do this?

In a world with many tax distortions, why would you alter imputation - the one element that is first-best? Taken together with imputation, our company tax rate seems about right. Lowering it just increases the distortions.

 

Stephen Grenville is a former deputy governor of the Reserve Bank of Australia and a visiting fellow at the Lowy Institute for International Policy in Sydney.