Companies — the role and purpose of company income tax
Company income tax has two basic roles: as a withholding tax on income earned by Australian residents, through shares in a resident (Australian) company; and as a final tax on (generally Australian source) income earned by non‑residents, through shares in an Australian company or a non‑resident company's branch in Australia.
The design of Australia's company income tax system has historically taken account of both these roles. This has influenced decisions about the company income tax rate, base and other rules, and the interaction of company income tax with the taxation of resident and non‑resident shareholders.
A withholding tax on residents
Company income tax reduces or removes potential tax advantages for residents from earning income through a company and deferring personal income tax until such time as company profits are paid out as a dividend, or the shares are sold. The income potentially sheltered from personal income tax can be either income from investments or labour income from the labour of owner‑managers, subject to personal services income rules.
Where a shareholder's personal tax rate (including consideration of income support payments) exceeds the company income tax rate, there can be tax deferral advantages from earning income through a company and retaining it there.
The net benefit from deferring tax is, however, smaller than the gross amount of tax deferred. An indicative estimate of the net benefit would be a return of around 3 per cent per annum on the amount of deferred tax. The potential value of the tax deferral benefit is also only one part of a more complex story. For example, the cash‑flow needs of an individual or family may preclude significant deferral, and the costs of creating and maintaining a company also need to be considered.
By providing a credit to shareholders for company tax paid on the profits from which dividends are paid, dividend imputation is the mechanism that converts company income tax into (in effect) a withholding tax rather than a separate (final) tax. Australia is one of only a few countries that still has a dividend imputation system but many other countries provide some form of relief to resident shareholders (for example, by exempting all or part of the dividend, or taxing dividends at reduced rates).
