A Literature Review Of Franking Credit And Market Valuation Dividend In Australia Essay.

Identify Keywords and think about alternative keywords

"Your aim is to write a review of literature which attempt to obtain a reliable estimate of the market value of dividends and franking credits with a particular focus on a method employed.

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Try different combination of keywords

1. “franking credits” AND value
2. “franking credits” AND dividends
3. “franking credits” AND “market value”
4. “imputation tax credits” AND dividends
5. “imputation tax credits” AND “market value”
6. “imputation tax credits” AND value

Long-Term Price Reaction to Dividend Reduction in an Imputation Environment–Evidence from Australia.

Insider ownership and dividend policy in an imputation tax environment. 

Effect of higher capital requirements on the funding costs of Australian banks.

Impact of dividend imputation on corporate tax avoidance:

Mid market focus: Company tax rates Consider the total tax liability. 

Identifying and Using Keywords

A literature review of a topic presents the facts and opinions provided by previous researchers or authors. Present study presents a literature review of franking credit and market valuation dividend in Australia. The report initiates with the basic core of the meaning of franking credit, and further other related topics have been discussed in detail in order to depict an appropriate conclusion.

Franking Credits also recognized as Imputation Credits are kind of tax credit that permit Australian Companies to pass on tax paid at the corporate level to stakeholders.  The reimbursement is these franking credits which are utilised to decrease income tax paid on dividends or potentially be received as a tax repayment. As per assertions of Dixon and Nassios, (2016) if a person needs to understand about Franking Credits correct place should be considered for that. Essentially, franking credits discontinued the double taxation of corporate income as the tax paid at corporation level can be approved to the investor. Richardson (2017) specified that for being qualified it is important to receive franking credits, which individuals require to hold and further shares at risk for over 45 days at risk, it is not inclusive of purchase and sale dates, thereby it comes into effect in a 47-day investment period. The refund is relevant when their total accusation credits are connected to their franked dividends paid which goes beyond their basic income tax legal responsibility for the year. Further, in accordance with the study of Richardson (2017), the cash amount is available for being returned to them which represents the number of surplus imputation credits. To this note, this will consecutively decrease their basic income tax legal responsibility to zero. In case if assessee needs to lodge an income tax return, an individual can apply it to claim a repayment of surplus imputation credits. On the other hand, if they do not need to lodge a tax return, the repayment is accessible on request. 

Australia is operating under a dividend imputation system of taxation instead of referring to a “classical tax system”. In accordance with the study of Woellner and et al., (2016) classical tax structure a company pays tax on its incomes. Further, at the time assessee hand out incomes to their investors and the ensuing income to the stakeholder is further taxed twice in the hands of the shareholder at their marginal tax rate. The meaning of the dividend imputation structure is to avoid this double taxation of business income. Though, the benefit is available only for Australian residential taxpayers and not for non-resident taxpayers. The imputation structure offers credit for income tax paid at the business level that can be further approved to a shareholder with a bonus paid by the business (Woellner and et al., 2016).  Moreover, with the dividend imputation structure business tax can be considered as a preservation tax next to the tax at the personal level.  Further, Woellner and et al., (2016) specified that dividends that are paid elsewhere or after corporate-tax incomes could almost go together with a “franking” credit to the level of the business tax paid.  Furthermore, the franking credits can be exercised as credits next to the tax accountability of the receiver at their applicable rates of tax. Consequently, the profits of the business are eventually taxed at the tax rate of the shareholder who obtains the dividends.

The Meaning of Franking Credit

The increasing level of undistributed franking credits that is detained by Australian companies offers a vital mystery for finance theory. In accordance with this in 1987, the Australian administration has build up the structure of tax credits that help to tackle the issues of double taxation of dividends. Cummings and Wright, (2016) asserted that double taxation of dividends occurs in a traditional organization at the period when salaries are taxed at the business level at the corporate tax rate and another time at the level of investors however at the period when dividends are taxed at the investor’s individual tax rate (Cummings and Wright, 2016).  Moreover, in Australia, a tax credit is equivalent to the Australian business tax paid on earnings and is allowable to occupant investors and is also connected to the dividends that occupant investor obtains. Thus, such this tax credit is known as dividend imputation credit. In accordance with a specification provided by Cummings and Wright, (2016) superficially it can  be predicted that corporation will make payments of all dividends that influence  the credit  because  these  are precious in the hands of occupant shareholders. However, it is observed that  substantial franking credit balances have mounted up  in the current years.

Furthermore, with the preface of the dividend imputation system, Australian occupant shareholders are credited with Australian business tax paid by the Australian company in which they usually make an investment.  However, such credits are also known as franking credits which are further linked up with the dividends and dispersed by Australian corporations to occupant investors moreover can be fully or partly franked dividends. Dixon and Nassios (2016), specified that such transformations in the Australian tax structure generated the incorporated tax system for occupant shareholders through the entire income are being taxed at the marginal income tax rate. The mere exclusion from such structure is non-resident shareholders and occupant organization that are not incorporated with authority. The precise exclusion of non-resident taxpayers is mainly significant to be known to the non-resident investors to manage above 40% of the equity planned on the Australian Stock exchange. 

The formula to compute franking credits (assuming they are 100% franked) is;

Franking Credits = (Dividend Amount / (1-Company Tax Rate)) – Dividend Amount

The reason behind measuring the imputation tax system is, to stop the business profits from being taxed double. McClure and et.al, (2018) concluded that previously, corporation’s revenues were taxed at the business level, and taxed over again in the appearance of dividends paid out to investors as individual income tax. Within the Australian imputation tax structure, a franking credit is dispersed to the persons by means of dividends to make up for individual taxation accountability. The franking credit signifies the total of individual taxation that is already paid at the business level (Toth and Burns, 2016).  Furthermore, Imputation credits in Australia have a face value of one dollar per credit that could be maintained as a refund to offset personal tax accountability. 

Most common method of estimating market value

Gamma in the Weighted average cost of capital

The Dividend Imputation System in Australia

Balachandran and et al., (2017), asserts that the specified method is an appropriate theoretical structure which represents the manner in which franking credit is changed through the impact of after tax-cost of capital. Earnings before interest and taxes, i.e. the company’s operating income is

X_o=X_G+X_D+X_E

In the above equation, XO represents operating income, XG is taxation rate, XD is debt holders’ part of operating income and XE is equity holder part of operating income.

The amount Tx(X0-XD) represents the amount collected as tax from the government. Moreover, a part of same which is represented as γ(gamma) specifies the part of the tax which will be rebated against personal tax. In other words, it can be said that it is that part of the tax which is received by the government at the company level and provides an increment to franking credit. Gruen (2016) specifies that Gamma is applied for pre-payment of personal tax liabilities.

Represents the market value of franking credit, i.e. the keenness of an investor relating to the amount payable for face value for attaining franking credit. In case of investor place full value of the franking credit, it is presented as theta of 1 and in case investor investors had no value for franking credit than same is presented as 0. Further, Toth and Burns (2016) specified that franking credit market value could be impacted by evaluating the manner in which stock market price reacts on the distribution of dividend and franking credit. As per assertions of McClure and et al., (2018) the stock price will have a negative impact as the market value of franking credit along with dividend are paid in cash. Thus, the average market value of franking credit can be attained through detail investigation across a huge number of dividends of past years.

Conclusion

It can be concluded from above study that although the concept and confirmation are still not clear, the idea that imputation has not much effective for share prices as well as the cost of capital placed greatly towards a range of potentials. Furthermore, it is more probable that imputation has various effects on share prices, yet in some cases, it is merely in firm conditions, for example, smaller, and domestic corporations. Additionally, imputation comes into view that it has prejudiced behaviours, and from which various are valuable. Business tax rate (30 per cent on large companies) additionally it has confident superior dividend payouts, and perhaps inferior business influence and a tendency for Australian corporations to spend nationally at the edge. As per the consequences people consider that the imputation system has made an optimistic contribution to the Australian financial system. 

References

Balachandran, B., Henry, D. and Vidanapathirana, B., 2016. Long-Term Price Reaction to Dividend Reduction in an Imputation Environment–Evidence from Australia. Sage.

Balachandran, B., Khan, A., Mather, P. and Theobald, M., 2017. Insider ownership and dividend policy in an imputation tax environment. Journal of Corporate Finance. 1(1). pp. 82-93

Cummings, J.R. and Wright, S., 2016. Effect of higher capital requirements on the funding costs of Australian banks. Australian Economic Review, 49(1), pp.44-53.

Dixon, J.M. and Nassios, J., 2016. Modelling the impacts of a cut to company tax in Australia. Centre for Policy Studies, Victoria University.

Dixon, J.M. and Nassios, J., 2016. Modelling the impacts of a cut to company tax in Australia. Centre for Policy Studies, Victoria University.

McClure, R., Lanis, R., Wells, P. and Govendir, B., 2018. The impact of dividend imputation on corporate tax avoidance: The case of shareholder value. Journal of Corporate Finance, 48, pp.492-514.

Richardson, D., 2017. Company tax and foreign investment in Australia. Routledge.

Toth, S. and Burns, A., 2016. Mid market focus: Company tax rates: Consider the total tax liability. Taxation in Australia, 51(5), p.245.

Woellner, R., Barkoczy, S., Murphy, S., Evans, C. and Pinto, D., 2016. Australian Taxation Law 2016. OUP Catalogue.