By Robert Gottliebsen
As the Australian economy reels in the wake of local and US interest rate rises the government has decided introduce deep uncertainty into a pillar of the Australian share market – franking credits.
And the franking attack comes at the same time as Treasurer Jim Chalmers is launching a similar attack on another key pillar, superannuation.
In the case of superannuation it is not the $3m cap that raises the alarm but rather the draconian taxes introduced to enforce it.
The franking attack uses a similar mechanism with powerful legislative powers accompanied by an assurance they won’t be unfairly used.
The Treasurer’s effort to ‘de-Keating’ Australia that started with his remarkable January manifesto that, I explained under the heading ‘Jim Chalmers’ divine intervention ends Keating-era prosperity’, is now gathering pace.
Chris Bowen’s franking attack helped cost Bill Shorten the 2019 election.
The Chalmers’ attack is less precise but, longer term creates uncertainty that is arguably as devastating.
And because it is backdated to last September it has already created extreme doubt to a legitimate a franking credit dividend declared by a listed Australian company.
If the Chalmers Bill passes through parliament many more will follow. BHP is in a vulnerable space and will need to be careful.
To understand how this new attack works readers need to understand that it is masked by a legitimate franking credit refinement that, in my view, does not attack the share market franking pillar.
Accordingly, the first part of the act is a series of measures dealing with various dubious uses of franking credits when companies undertake share buybacks. On that front Chalmers deserves praise.
But then comes the killer blow.
Treasury hated Paul Keating’s franking credits from day one. As former Treasurer Peter Costello recalls, most new treasurers get a list of measures to raise money from Treasury and its soulmate the Australian Taxation Office.
For many years buried in the regular treasury list was its plan to give the ATO the power to substantially reduce franking credits.
Most new treasurers picked up the franking credit motivation but Scott Morrison when he was treasurer was tricked and actually announced a very similar plan to the one that being embraced by Chalmers.
But, streetwise, Josh Frydenberg became treasurer before it was implemented. It took Frydenberg less than a minute to realise what the ATO and Treasury were up to so he simply didn’t proceed with it.
Chalmers has embraced the plan.
Currently franking credits are seen as a shareholder asset that can be distributed by being attached to a dividend. That freedom era ends if the legislation is passed because the ATO is to be handed the power to declare that a dividend is what the legislation describes as being “unfrankable”
The first requirement to make a distribution “unfrankable” is that “the distribution must not be consistent with an established practice of the entity of making distributions of that kind regularly”.
Presumably the intention of the legislation is that companies will declare in advance their policy of dividend distributions which may be related to profit levels. But any variation, including special dividends linked to prosperity, look vulnerable but there is a morass of words that could have many meanings.
The second essential requirement for a distribution to be declared “unfrankable” is there must have been an issue of equity interest (i.e. capital raising) by the entity or any other entity. This requirement is broad.
The issue of equity interest can occur before or after the distribution. The entity issuing the equity interests does not need to be the company paying the dividend. Another morass of words follows but the bottom line is that any dividends that are suspect under the first requirement should not be accompanied with equity issues.
And so in the BHP takeover bid for Oz Minerals there is a provision for a special franked dividend by Oz Minerals which might be “unfrankable” if BHP had used shares rather than cash as part of the bid.
Indeed BHP needs to make an undertaking not to issue equity for an extended period for fear that it would make the Oz Minerals dividend “unfrankable”.
The morass of words give the ATO huge power he matters like this.
The listed company Tribeca Global Natural Resources has declared a fully-franked interim dividend of 5c per share and a special fully franked dividend of 7.5c per share.
It goes ex-dividend next month. It has also announced a share issue plus a dividend reinvestment plan. The franking credits in its special dividend are in grave jeopardy and even franking in the normal dividend might be at risk given the issue and dividend reinvestment plan plus the uncertainty created by the morass of words in the bill
A fundamental pillar of the Keating franking credit strategy was that companies would pay high dividends and replace the capital when appropriate.
It was a brilliant strategy that greatly contributed to Australia’s prosperity and it‘s reversal via uncertainty will reduce that prosperity.
Moreover it considerably increases the dangers to our banking system in a crisis. Around 2008 and in the early Covid period banks clearly paid dividends out of funds raised in equity placements which was encouraged by APRA who wanted to ensure the solvency of our banking system.
If we have another crisis APRA will again urge banks to pay dividends to hold their share price and fund those dividends out of equity issues. This legislation stops that safety mechanism by declaring those dividends “unfrankable”.
In another area of policy making the Australian government wants to encourage local manufacturing.
But manufacturing in an inflationary environment requires extra equity to fund working capital so while some working capital/dividends can be financed via debt, equity issues are vital.
Warren Buffett defined the impact of inflation on manufacturing working capital as “a gigantic corporate tape worm that eats cash flow from the inside“ due to its impact on working capital.
The government’s new manufacturers will be hit by the Chalmers blows and many will be sold overseas.
Chalmers will of course say I am exaggerating and have it wrong.
That’s his privilege.
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