By Tony Boyd

Draft legislation aimed at closing a loophole in off-market buy-backs contains a powerful sleeper clause that will wipe out billions of dollars in franking credits that would normally be available for distribution to shareholders.

The clause was uncovered by fund manager and franking credit crusader Geoff Wilson as part of his review of the proposed legislation to stop companies distributing franking credits through buy-backs.

“The current government is in the process of destroying efficient capital formation in Australia by dismantling the franking system,” he says.

Wilson, who founded Wilson Asset Management, has begun a campaign against the proposed law by urging the 130,000 investors in WAM’s listed investment companies to make a submission to Treasury.

He has also started meeting federal politicians to urge them to lobby against the changes.

Wilson tells Chanticleer he will be trying to win the support of Senator David Pocock, who holds the balance of power in the Senate.

In the October federal budget, federal Treasurer Jim Chalmers said he would raise $550 million over the next four years “by aligning the tax treatment of off-market share buy-backs undertaken by listed public companies with the tax treatment of on-market share buy-backs”.

The franking credit system was introduced by then-treasurer Paul Keating in 1985 to stop the double taxation of dividends. Franking credits, or imputation credits, are a tax credit paid alongside company dividends for imputed tax already paid by an Australian company.

Under the current law, a company undertaking an off-market share buy-back can make any part of the purchase price a dividend which can be franked, thus triggering a franking debt in the company’s franking account.

“The purchase price will be taken to be a dividend to the extent that is not debited to the share capital account or non-share capital account of the company, which will constitute a frankable distribution,” the current law says.

The draft legislation – Treasury Laws Amendment (Off-Market Share Buy-Backs) Bill 2022 – published on November 17 includes a new clause that takes the crackdown on franking credits further than anticipated.

The proposal says: “If a listed public company undertakes an off-market buy-back, a franking debit arises in the company’s franking account.

“The amount of the debit is equal to the debit that would have arisen if the company were not a listed public company and the purchase were a frankable distribution (because the whole or part of the purchase price were not debited to the company’s share or non-share capital account) that was franked at the company’s benchmark franking percentage, or at a franking percentage of 100 per cent if the company doesn’t have a benchmark franking percentage for the franking period.”

Wilson says in his submission to Treasury that “the government is proposing to eliminate franking credits permanently to the extent it would have been paid out in a fully franked dividend to shareholders, should a company wish to conduct an off-market share buy-back in the future”.

“So, not only is the government further limiting a company’s ability to distribute franking credits to shareholders, but it is also now proposing to permanently take those franking credits away from companies, in turn denying them the ability to distribute legitimate tax payments made on behalf of their shareholders,” he says.

“The above changes were added to the legislation and were not announced in the federal budget on October 25. It is a significant negative addition which looks to further disenfranchise Australian companies and investors.”

Latest available data from the Australian Taxation Office shows that Australian companies had accumulated a total of $429.16 billion in franking credit balances at June 30, 2020.

This amount rose by $36.6 billion in fiscal 2020 because companies do not distribute all of their taxable credits each year. This is because companies only pay out about 50 to 60 per cent of earnings.

If the $36.6 billion in franking credits was paid out as fully franked dividends, then another $85.5 billion in fully franked dividends could have been paid, given that the formula for franked dividends is $36.6 billion x 70/30.

Wilson is using some comments made by Keating in an article published in 2013 to support his argument that Treasury has a set against franking credits and wants to kill the system entirely.

Keating said in the article published by “Treasury try to remove franking every seven years.”

Wilson also likes the Keating comment in the same article that “dividend imputation revolutionised capital formation in Australia”.

Wilson tells Chanticleer that successive moves by the Albanese government against franking go against comments made by then-opposition leader Albanese and Chalmers before May’s federal election, that a Labor government would not touch franking.

In September, the new Labor government proposed legislation to retrospectively stop companies paying shareholders fully franked dividends that were funded by capital raisings.

This crackdown on dividend imputation credits would 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.

The government later said it would not make the move retrospective.

Wilson says the government appears intent on stopping companies paying out franking.

“What they’re saying is the only way you can pay a franked dividend is if you either pay 100 per cent of your earnings or you pay out half your earnings, and then you’re going to end up with surplus franking for the rest of your life,” he says.

“You can’t pay out a dividend if it is associated with any equity raise. That means the only way you can pay it out is to gear up, and companies aren’t going to gear up just to pay out franking.”

Wilson sees this as an attack on capital formation in Australia. He says franked dividends have lowered the cost of capital and made it easier for companies to raise capital during times of crisis, such as the global financial crisis.

He says Treasury’s moves sit oddly with the moves by the Australian Prudential Regulation Authority, which said during the COVID-19 pandemic that banks could not pay dividends.

“Two or three months later, when the system had not frozen, APRA said you can pay a dividend but raise as much capital as you can.

“So, effectively, any bank that would have raised capital under this new regime, those dividends would be unfranked.

“Any company that has a dividend reinvestment plan that raises capital – which is raising capital to help pay the dividend – they’re not going to be able to do that.”

The draft legislation is open to public submissions until Friday night.

Chanticleer sought a comment from the Treasurer’s office, but did not hear back.

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