Investors are set to be rewarded with a deluge of share buybacks in the next few months as companies race to beat Labor’s proposed crackdown on cash refunds of franking credits before a potential change of government.
Board directors, fund managers, investment bankers and equity analysts expect a spike in off-market share buybacks and special dividends, with companies seeking to funnel dividend imputation credits to low-taxed shareholders like self-managed superannuation funds (SMSFs).
“Over the next six months there are going to be quite a few companies announcing either off-market buybacks to return franking credits to shareholders while that rebate is available and/or special dividends, again using the franking balance within balance sheets,” Ausbil’s co-head of equities John Grace said.
Prime candidates for capital management initiatives are companies generating large domestic profits, with surplus capital and excess franking credits, such as Woolworths and Caltex.
If Labor wins the federal election set for mid-May next year, the deadline for excess franking credits to be paid as cash refunds to low-taxed investors would be June 30.
About 200 agitated retirees who would lose their cash refunds from Labor’s tax crackdown attended a House economics committee inquiry led by Liberal chair Tim Wilson in Sydney’s Dee Why on Friday.
Institute of Public Accountants general manager of technical policy Tony Greco said companies would favour off-market buybacks, so they could “skew” the distribution of franking credits to SMSFs and other low-taxed shareholders.
“There is an extra impetus in the marketplace to pass on these credits before they become less valuable,” Mr Greco said.
“There is definitely a cost to Treasury because companies are effectively streaming the receipt of those credits to a segment of their shareholders which will be able to maximise the benefit.”
Dividend imputation was introduced by then-Labor treasurer Paul Keating in 1987 to eradicate double taxation. It entitles a shareholder to a tax credit on a dividend which is equivalent to the tax already paid by a company.
The Howard government made the system more generous in 2000 so that if a shareholder had an imputation credit higher than their personal tax liability, the investor would receive the excess credit as a cash refund.
Australia is the only advanced economy with a fully refundable dividend imputation credit system and Labor wants to bring the system back in line with its original 1987 design.
The change, should Labor be elected at the federal election, is set to be introduced from July 1.
“Companies with excess franking credits are going to look to give back credits to shareholders,” Tribeca fund manager Jun Bei Liu said.
Woolworths is one company that could return excess capital to shareholders, she said, and added “we expect a lot of companies to be making those decisions now”.
ANZ Banking Group, BHP, Rio Tinto and Woolworths have recently announced large share buybacks, mainly reflecting surplus capital from asset sales or strong profits.
“You’ve already seen it with BHP and Rio – that’s coincidental with asset sales – but is [also] certainly returning franking credits to shareholders while that rebate is available,” Ausbil’s Mr Grace said.
“Over the next five months in particular – up to that potential election – I think that you will see corporate Australia react,” he said. “That’s the message we are getting.”
The big four banks are unlikely to do extra buybacks, because their profits are under pressure from the royal commission and housing slowdown.
Labor’s policy would raise an estimated $55.7 billion in revenue over a decade. Franking credits for company tax paid would still be available for shareholders to avoid double taxation.
After a backlash by investors and retirees in March, Opposition Treasury spokesman Chris Bowen softened the policy to protect more than 300,000 low-income full and part pensioners.
More than one million shareholders could lose cash refunds under the Labor proposal and there has been vocal opposition to the plan from some equity fund managers including Wilson Asset Management’s Geoff Wilson.
Mr Wilson said that all boards should consider returning excess franking credits to shareholders. “They belong to the owners and if Labor is going to diminish their value, it’s incumbent on boards to distribute them,” he said.
Under an off-market share buyback, shareholders are offered the opportunity to sell their shares back to the company.
In return, the shareholders receive franking credits. It is advantageous for SMSFs and shareholders with low taxable incomes because they can attain refunds.
Shareholders on higher marginal tax rates above the 30 per cent corporate rate don’t participate as much in optional buybacks because they have to pay top-up tax. But all shareholders benefit from the boost to the share price from the buyback demand and reduction in the number of shares that profits are distributed to.
Buybacks as a share of the ASX market capitalisation are about 0.5 per cent so far in 2018, above 2017 but below 2016, according to analysis by UBS.
“There’s been talk about companies doing more buybacks, but so far there is no real evidence of it occurring yet,” UBS head of quantitative research Paul Winter said.
A corporate adviser said curtailing the generosity of franking credits may encourage low-taxed investors to sell shares and shift into other assets.
Hence, companies might offset this selling pressure by increasing buybacks to support the share price.
A company director and former investment banker said many companies would probably announce off-market buybacks at their financial results in February.
The profit-reporting season in August was too early for election-driven buybacks, because companies were not prepared and it is now increasingly likely Labor will win the election, the person said.
Most boards prefer to have Australian Taxation Office clearance for buybacks, which usually takes about four-six weeks after an application.
In 2015 the ATO warned companies against purely using equity raisings to fund franking distributions such as off-market buybacks or special dividends.
In 2016, the government announced it would introduce a measure to prevent a company from attaching franking credits to distributions to shareholders made outside or additional to the company’s normal dividend cycle, if the distributions are funded directly or indirectly by capital-raising activities that result in the issue of new equity interests.
The legislation has not been introduced into Parliament.
Treasury’s annual tax expenditure review statement says the proceeds paid to shareholders who participate in an off-market share buyback are split into a dividend component and a capital component.
“The dividend component of the buyback proceeds may be fully franked,” Treasury says.
“This allows companies that undertake off-market share buybacks to distribute franking credits to participating shareholders beyond the level that would normally be available.
“Treating part of the proceeds as a dividend makes off-market share buybacks more attractive to low marginal tax rate taxpayers. This facilitates streaming of franking credits to those shareholders that can obtain the most benefit.”