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Buyback reform may have ‘unintended consequences’ for SMSFs: DNR Capital
The federal government’s plan to close a tax loophole for off-market share buybacks and capital raisings could have “unintended consequences” for Australia’s franking credit system, DNR Capital’s Scott Kelly has argued, with self-managed superannuation funds (SMSFs) set to feel the biggest impact.
The proposed Treasury Laws Amendment Bill 2023, introduced to Parliament in March, would target franked dividends funded by off-market share buybacks and capital raisings in a bid to align their tax treatment with that of on-market buybacks by listed companies. It’s expected to save the budget $600 million over four years.
While the legislation “effectively aligns the tax treatment of off-market share buybacks with on-market share buybacks” and has received “very little industry pushback”, DNR Capital has identified risks of “unintended consequences”, according to Kelly, portfolio manager for the DNR Capital Australian Equities Income Strategy. That’s particularly true for SMSFs and investors with low marginal tax rates, he added.
“Historically, large companies have often raised capital from shareholders through fully underwritten capital raisings and then paid out all that money raised as a franked dividend,” Kelly explained.
“But the government wants to clamp down on this move so that a company will not be able to pay out franked dividends that are directly or indirectly funded by capital raising,” he said, adding that while this “may not seem unreasonable” at face value, DNR Capital has concerns about unintended consequences.
“The first problem is that the proposed test to determine when companies can pay out fully franked dividends observes an established practice of paying dividends over time,” he said. “This potentially puts startups at a disadvantage given they tend not to pay out dividends in the first few years of operations.”
The proposal also apparently captures dividend reinvestment plans, which are a form of capital raising, Kelly noted. That means shareholders could lose franking credits over time.
Finally, he pointed out that under the proposal, companies would still be able to fund dividends by taking on debt, which could disadvantage smaller companies with less access to capital markets than large companies enjoy.
Moreover, DNR Capital is worried the proposed changes are “just the beginning of other, broader changes”, Kelly said, and will ultimately make Australia’s franking regime less effective.
“In our view, those who will be most affected by the changes are self-funded retirees and retail investors, and those investors with low and marginal tax rates,” he said. The proposals also increase the risk that franking credits will become permanently trapped within companies.
“And there are also broader implications for the economy upon which Australia’s franking regime has support investment and growth over time.”
Kelly said it’s likely franking-rich companies will increase their dividend payout ratios and pay out special dividends more regularly. “We still expect that there will be plenty of opportunities for investors to target companies delivering sustainable, growing, tax-effective income over time.”
Kelly joins other industry voices that have criticised the proposed changes, including Geoff Wilson of Wilson Asset Management, who has called the amendments “a clear backdoor attempt to dismantle the franking system” and a reversal on Labor election promises.
