The Impact of Full Franking Credit Refundability on Corporate Tax Avoidance

Abstract

The debate about the efficacy of Australia's full dividend imputation system and especially the potential abolition of the full refundability of franking credits has intensified in recent times. This article contributes to the debate by empirically examining the impact of the introduction of section 67-25(1) of the Income Tax Assessment Act 1997 effective from 1 July 2000 that allows shareholders to claim all franking credits attached to dividends, even if it propels them into a tax refund position. Consistent with expectations, evidence is found of an economically significant increase in cash effective tax rates (decrease in tax avoidance) for domestic firms relative to foreign firms and for dividend-paying domestic firms relative to non-dividend paying firms. This finding is even more pronounced for firms paying fully franked dividends. The results are consistent with the notion that firms undertake less tax avoidance in the post 1 July 2000 period given the presence of stronger incentives for them to pay corporate tax and suggest that an unintended consequence of a removal of full refundability of franking credits may be an increase in corporate tax avoidance.

Keywords: Taxation, Tax Avoidance, Income Tax Assessment Act 1997, Dividend imputation system, franking credits, tax avoidance, dividend