Corporate tax strategy under the Australian dividend imputation system

Abstract

Prior tax and accounting studies in the United States find that companies adopt strategies to aggressively minimise corporate tax, provided the expected tax benefits exceed the financial reporting costs. Also, where managers are remunerated on targets based on after-tax earnings or stock value they are likely to pursue more aggressive tax strategies.

This thesis extends this line of research to the Australian dividend imputation system in a period of tax rate reductions. In this system, corporate profits are ultimately taxed at the personal tax rates of shareholders and corporate tax becomes a prepayment of shareholder tax on dividend income. As corporate tax is not necessarily viewed as a cost, managers are likely to focus on maximising before-tax profit, distributing franked dividends (i.e., dividends that carry credit for corporate tax paid) and have little incentive to engage in costly tax-avoiding strategies. Tax rate reductions during the period 1999 to 2003 provide a setting to examine corporate tax strategies when faced with the opportunity to avoid tax.

This thesis uses the ratios of three effective tax rate measures to the statutory tax rate as the proxies for tax strategy and uses regression analysis to test four hypotheses using the data of 491 publicly-traded Australian companies. The first hypothesis predicts that companies distributing franked dividends have more conservative tax strategies than those that do not. The second hypothesis predicts that companies under close scrutiny by the Australian Taxation Office are also likely to have more conservative strategies than those that are not. Consistent with incentives to maximise before-tax profit, the third hypothesis predicts that managers remunerated with share options do not implement more aggressive tax strategies as predicted in a classical system of company tax. The fourth hypothesis predicts that managers continue to pursue conservative tax strategies in the years before tax rate falls and do not pursue aggressive tax strategies as observed under a classical tax system. All four hypotheses are strongly supported by empirical evidence.

One important tax policy implication of the findings from this study is that it provides empirical support for the notion that Australia's dividend imputation system protects the integrity of corporate tax revenue and this is an advantage compared to the classical system that taxes profits twice.