Dividend reinvestment plans :a tax-based incentive under the Australian imputation tax system

An innovative feature of the Australian tax code is the provision of "imputation tax credits" that reduce the effective tax paid by Australian investors on dividends received from Australian firms. The feature is generally regarded as providing a tax incentive for corporations or firms subject to Australian corporate tax to distribute available cash to investors rather than seeking to retain the firm's profits. More recently in Australia, dividend reinvestment plans (DRPs) have been increasingly utilised by firms that allow investors to have their cash dividends automatically reinvested in new shares issued by the firm. Such plans offer firms an alternative source of equity capital to either retention- or stock-financed equity capital. This article demonstrates the link between the tax liabilities of investors and the propensity of firms to avail themselves of a DRP innovation. We argue that the increasing use of DRPs in the Australian equity market subsequent to the introduction of the imputation tax system can be explained by tax-saving efficiencies that allow the firm the opportunity to lower its cost of financial capital. From a policy perspective, this will act to stimulate overall investment.