By John Kehoe
The Albanese government has shocked investors by proposing to retrospectively stop companies paying shareholders fully franked dividends that are funded by capital raisings.
The crackdown on dividend imputation credits will affect retail investors and superannuation funds receiving special dividends outside of the usual dividend payment cycle and companies that issue new equity to fund distributions to shareholders.
Treasury forecasts the “franked distributions and capital raising” measure will raise a relatively modest $10 million a year, but investors fear the cost to them will be larger.
The government has proposed backdating the “integrity measure” to 2016 to ensure that only distributions equivalent to realised profits can be franked, alarming investors in companies that have paid special dividends or issued new shares in the past six years.
The change could disallow some franking credits paid to retail shareholders, superannuation funds and trusts that receive dividends from public and private companies.
BDO tax partner Mark Molesworth said investors could receive surprise tax bills for special dividends they received since December 2016.
A government source said the change was designed to close a “loophole” on the “washing machine” of dividends, after Scott Morrison as treasurer originally announced in the 2016-17 mid-year budget that he would shut it down but never legislated it.
‘Labor is at it again’: Wilson
The surprise move, revealed in draft legislation released by Treasury this month, has brought back memories of Labor’s far bigger proposed crackdown on $11.4 billion of refundable franking credits that contributed to its 2019 election loss.
Wilson Asset Management chairman Geoff Wilson, who waged a public campaign three years ago, said, “unfortunately, Labor is at it again”.
“It didn’t take long for Labor to start on franking credits,” he said.
“The government is trying to introduce retrospective legislation that goes back to 2016 and attempting to stop fully franked dividends from Australian companies that have paid their full amount of tax.
“We will fight this every bit as hard as the assault on franked dividends at the 2019 election.”
Mr Wilson said the change would hurt fast-growing small and medium companies which raised money for working capital and paid dividends to shareholders.
Mr Wilson manages about $5 billion for 130,000 retail shareholders who benefit from franking credits.
His WAM business model is to sometimes acquire companies with strong franking credit balances, such as Macquarie Media and telco Amaysim.
In the explanatory material accompanying the new draft legislation, Treasury said the proposed amendments were an integrity measure.
“They prevent entities from manipulating the imputation system to obtain inappropriate access to franking credits,” it said.
“They will specifically prevent the use of artificial arrangements under which capital is raised to fund the payment of franked distributions to shareholders and enable the distribution of franking credits.”
Measure dates to 2015 ATO warning
The Australian Taxation Office publicly warned in 2015 it was concerned about capital raisings being used to fund the streaming of “trapped” company dividends to shareholders.
Sandon Capital founder and chief investment officer Gabriel Radzyminski said the most galling part of Labor’s proposal was to make the laws retrospective.
“Companies will have made good faith decisions in the past, based on prevailing laws, and the government is proposing to turn around and say ‘sorry, you shouldn’t have paid those franked dividends’.
“They’d ruled out touching franking, but they’re now attacking it from another angle.”
A government source said the consultation would discuss the proposed starting date, including the planned backdating to December 19, 2016, that was first flagged by Mr Morrison.
“The government is seeking stakeholders’ views on the exposure draft legislation and accompanying explanatory material implementing this measure,” Treasury told stakeholders.
The dividend imputation system works when an Australian corporate tax entity distributes profits to shareholders and can pass on a credit for company tax it has paid via a franking distribution.
Most resident shareholders that are individuals or superannuation funds can then claim a refundable tax offset equal to the amount of the franking credit.
Change announced in 2016
Mr Morrison as treasurer announced in the 2016-17 mid-year economic and budget update that the Coalition government would “prevent the distribution of franking credits where a distribution to shareholders is funded by particular capital raising activities”.
“The measure will apply to distributions declared by a company to its shareholders outside or additional to the company’s normal dividend cycle (a special dividend), to the extent it is funded directly or indirectly by capital raising activities which result in the issue of new equity interests,” Mr Morrison’s announcement said.
“Examples of capital raising activities include an underwritten dividend reinvestment plan, a placement or an underwritten rights issue.
“Where such arrangements are entered into, the corporation will be prevented from attaching franking credits to shareholder distributions.”
The change was never legislated, and the Coalition quietly shelved the policy.
Fifteen months later, in March 2018, then-Labor leader Bill Shorten announced a much broader crackdown on franked dividends, by announcing it would ban the refund of excess franking credits to investors who paid zero or minimal income tax. The measure was forecast to raise $11.4 billion over four years.
The Coalition and Mr Wilson waged a furious – and successful – campaign against the franking credits crackdown at the May 2019 election.
Anthony Albanese dumped the policy when he became leader after the election loss.
“While the call on the budget of franking credit arrangements is large, many small investors felt blindsided and it opened up a scare campaign,” Mr Albanese said in November 2019.
The Australian Taxation Office in 2015 issued a taxpayer alert raising concerns about franked distributions funded by raising capital releasing credits to shareholders.
“A company with a significant franking credit balance raises new capital from existing or new shareholders,” the ATO said.
“This may occur through issuing renounceable rights to shareholders.
“Shareholders may include large institutional superannuation funds.
“At a similar time to the capital raising, the company makes franked distributions to its shareholders, in a similar amount to the amount of capital raised.
“This may occur as a special dividend or through an off-market buy-back of shares, where the dividend forms part of the purchase price of the shares.
“We are concerned that the arrangement is being used by companies for the purpose of, or for purposes which include, releasing franking credits or streaming dividends to shareholders.
“This may attract the operation of the anti-avoidance rule.”
Treasury has set a three-week consultation period on the exposure draft legislation, between September 14 and October 5, for stakeholders to provide feedback.
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