Corporate Australia has often been criticised for failing to grasp the full potential of Asia, since former PM Julie Gillard launched the ‘Australia in the Asian Century’ white paper seven years ago.
I agree that Australia is at risk of becoming too inward-looking. The Asian middle class is expected to grow to 1.7 billion people in 2020 and to 3 billion in 2030. We need to look out to the world if we are going to maintain our standard of living.
But our companies have been put off investing in Asia, as institutional shareholders have pushed them to expand their domestic rather than overseas operations. They have been encouraged to return capital in the form of special franked dividends.
As a country, we need large Australian-based multinationals which bring to our economy considerable benefits from corporate functions such as Treasury, Strategy, Procurement, Risk, Insurance and Marketing. These advantages have been underplayed. We do not want to become just a “subsidiary economy”.
Australia introduced the imputation regime in 1987 and made franking credits refundable for superfunds, individuals and charities about 17 years ago. I believe it is time to revisit and, possibly, rebalance our tax system such that we become more outward-looking.
Conceptually, one option is to move to a partial imputation system, using the funds saved from reduced franking credits to lower the company tax rate and to put a discount on unfranked dividends paid by Australian companies. This could be a general direction for change.
There would be five key advantages of such a move:
Firstly, it would reduce the disincentive for Australian companies to invest offshore and enhance the chances of retaining head offices of major businesses in our capital cities. This would be consistent with our need to look out to the world in the Asian Century.
Secondly, such a proposal would slightly tilt the investment bias away from safer short-term investments (which are more likely to produce franking credits) and towards longer-term ventures, possibly riskier, but ones which could produce significant market-generating innovations.
Third, it would reduce the incentive for high dividend payout ratios which can act as a disincentive to innovative investments – by, say, our major banks in the Fintech sector.
Fourthly, it would improve the attractiveness of R&D, through the discount on unfranked dividends. Currently the tax concessions associated with R&D cannot be passed on to shareholders.
And finally, the partial imputation system would still provide an incentive, albeit reduced, to pay Australian tax. It would also lessen the incentive for streaming taxable dividends.
Would such a proposal change investment? There are four important groups which would not be significantly impacted:
Large listed companies with a dominant international shareholder base. These entities have a foreign cost of capital. Indeed imputation, for this group, is simply a subsidy to domestic investment.
Australian subsidiaries of large international groups are mostly not affected, although it may make some difference on withholding tax.
Small to medium private groups tend to use structures which do not rely on imputation, except for Self-Managed Super Funds. Finally, there is an investment group, particularly in property and infrastructure, which largely use trust structures, so that tax is paid at the unit-holder level. They do not rely on the imputation system.
So who would be most affected? Large and medium-sized companies with a dominant domestic shareholder base, for whom imputation does lower the cost of capital. But looking out to the future, we need significant Australian investment in overseas economies. A partial imputation system with a lower company rate and a discount on unfranked dividends, would assist in achieving this.
It is not without accident that the last two decades have seen many countries retreat from full imputation, and adopt a partial system. The list includes the UK, Germany, France, Italy, Finland, Norway, Singapore and Malaysia. The reason is largely that as our world becomes more global, imputation produces less benefit.
Half a millennium ago, in the first half of the 15th century, China had the best maritime fleet in the world. They had reached the east coast of Africa well before Henry the Navigator, and Australia before Hartog and Cook.
However, the Confucians of the Ming Dynasty court wanted to look inward, closing shipyards and limiting the size of ships that could be built. The next five centuries saw a substantial decline in living standards in China.
In 1983, Deng Xiaoping gave a speech to select members of the Central Committee of Chinese Communist Party, advocating that China look out to the world. Thus begun the greatest rise in living standards the world has seen.
We need to look out more.
First published in The Australian 25 september 2017