Taxes, Corporate Financial Policy and Investment Decisions in Australia*

Abstract

This paper presents a formal model of an optimizing firm to examine incentives provided by Australia's full imputation scheme in combination with its capital gains tax provisions. It explores how the tax system affects optimal dividend and financial policy. It derives an expression for the cost of capital for corporate investment which takes account of the way in which corporate tax payments influence firms' ability to pay franked dividends and examines how this is affected by capital gains taxation.

Depreciation Provisions and Investment Incentives under Full Imputation

“…As in Benge (1997) it is assumed that a firm maximizes its value subject to a set of constraints. As is derived in the earlier paper, the firm's exdividend value at the end of period 0 will be given by = (it+l(lm) -a~x , +~) / ( l -c ) a n d other variables are as defined in Table 1.…”

“…One case is where firms pay unfranked dividends. Australian tax provisions provide incentives for franked dividends to be paid before unfranked dividends and for firms to retain unfrankable eamings (earnings which would be unfranked if paid as dividends) and repay debt or lend instead (Benge 1997). Given this paper's assumption of an exogenous ratio of debt to capital stock.…”

“…In our model the value of the firm is set endogenou~ly.~ Benge (1997) provides a formal model to consider the financial policy biases created by the Australian tax system for a widely held company and also provides an expression for the cost of capital for an optimizing firm using no debt. The model of the company presented in this paper is largely the same as in the earlier paper.s However, in this paper we consider a partially debt-financed company and examine how the cost of capital would compare with that of an unincorporated enterprise under a variety of idealized depreciation rules.…”

“…The model presented in this paper rests on a number of key assumptions which are discussed more fully in Benge (1997). It abstracts from transactions costs and any signalling benefits of dividends or debt.…”

A Measure of the Efficacy of the Australian Imputation Tax System*

“…4 4 For a discussion of various tax‐induced biases that exist under the Australian imputation tax system, see, for example, Officer (1981), Finn (1981), Howard and Brown (1992), Benge (1997, 1998, 2001) and Review of Business Taxation (1999a). …”