By Kang Beng Hoe The first article dealt broadly with how the new single-tier system will work with regard to dividends and the effect the change will have on a broad spectrum of corporate and individual shareholders.

As there are a number of issues arising from the proposed introduction of this new system (other than the lack of a tax refund for individuals who are not taxable or taxed at a low marginal personal tax rate and thus entitled to claim the tax credit attached to taxable dividends), this article elaborates on some specific aspects of the system.

It examines the issues faced by companies (especially listed ones) when considering dividend options during the transitional period.

Individuals receiving dividends and who have been claiming tax refunds each year are amongst those most concerned. The question that has been asked is whether they will continue to receive these refunds for the next six years, i.e. the transitional years up to the end of 2013?

Kang Beng Hoe

The answer would be yes if the companies paying the dividends continue to pay “franked” dividends (the term refers to dividends with a tax credit attached). This leads to the related issue pertaining to how companies paying dividends to their shareholders would view the situation in light of the single tier dividend option.

Public-listed companies generally have a fairly consistent dividend payout policy. The level of a company’s dividend payments would often correlate with its profitability and the need to retain earnings for future business expansion and for making acquisitions. In this scenario, it would have accumulated a large tax credit balance, which will enable it to continue to pay franked dividends.

There will be no reason for it to change this practice and to start paying single tier dividends. There is no benefit to the company in doing this. It would therefore be fair to say that dividends paid by most listed companies will continue to be franked dividends during the transitional period.

A company paying a 10% franked dividend will pay out less cash than if it paid a single tier dividend at the same rate.

This is a further reason for not switching to the single tier system until the actual due date arrives.

The inability to continue to pay franked dividends could be faced by those group holding companies that pay dividends to their shareholders at a time which generally coincides with the dividends received from their subsidiaries. Such companies thus rely on the flow of dividends from its subsidiaries to create the tax credits (which is the case under the current imputation system).

However, under the single tier system, there would thus be no accumulation of tax credits at the holding company level. Therefore, the change in the law brought about by the single tier dividend system could put these holding companies in a bind. For companies with a Dec 31 year-end, the remedy lies in their carrying out an exercise before the financial year-end to extract the tax credits remaining in the subsidiaries by draining their retained earnings via dividend payments.

The holding company will not be able to flow the tax credits to its shareholders where the dividends are paid after 2007. If for various reasons they are unable to flow dividends up from their subsidiaries, then they may need to opt to pay single tier dividends.

Unfortunately, for the companies with an earlier year-end, say June 30, this exercise is not available to them because dividends paid after June 30 will not count towards establishing available tax credits. Such companies may also have to opt into the single tier system in order to meet their dividend commitments.

The transitional provisions incorporate a number of measures designed to prevent the use of arrangements for the sole purpose of streaming dividends in order to benefit from the receipt of dividend credits. Thus companies are precluded from passing tax credits via dividends: