BHP buyback and franking debate

Thursday, November 22nd, 2018

In today’s report, we republish two articles written for publication in the Australian Financial Review that were penned in recent weeks.

The articles are related because they both touch on franking. The first (a letter to the AFR) concerns the utilisation by BHP of franking credits to affect the buyback of its shares. The second extends the debate concerning franking into a broader discussion regarding the objectives of Australia’s superannuation system.

Of significance is our view that Labor’s proposed changes to franking, if implemented, will make “franked” buyback schemes (such as BHP’s) obsolete.

In any case, it is remarkable that buyback schemes, which involve the streaming of franking credits and which create contrived capital losses, have the approval of the Australian Taxation Office.

It is unfortunate that the benefits of franking, which should accrue to those investors that utilise franking in a reasonable fashion to secure their retirement, are abused by some major Australian companies.

The BHP buyback scheme, like many others before it, presents as inconsistent with the true intent of the dividend franking system in Australia. Therefore it is surprising that the BHP scheme has not been properly scrutinised and questioned given the Labor Party’s intended changes to franking if elected to Government.

BHP buyback – Letter to the Editor

“Dear Sir,

The BHP buyback, with its streaming of franked dividends and the creation of capital losses for a fortunate few, exemplify how absurd the tax governance and therefore the management of Australia’s fiscal policy has become.

Further, the decision by the BHP board to construct a convoluted and discriminatory capital return strategy as opposed to a simple cash dividend to all shareholders needs an explanation.

The costs of the BHP structure will be high – probably millions – and shareholders are left to work out what to do and ponder whether they will benefit from the possible outcomes between participate or not participate.

BHP shareholders will recall the 2011 version of the BHP buyback at $38 per share. How poor that decision has been for shareholders ever since!

In my opinion, schemes like this should not be legal and in any case, directors need to decide if these schemes are really in the best interests of all shareholders. More so BHP which is a large resource company subjected to multiple cycles including commodity prices, currency, China growth, equity market risk and the current uncertainty as President Trump implodes the US budget.

Whilst BHP should be ready to buy back shares and they should only do so when they are clearly undervalued based on some assessment by them as to what is fair value. I suspect they have no idea of fair value as evidenced by their decision to buyback at a discount to a VWAP price rather than a set price. They did the same thing in 2011.

Meanwhile, Canberra is asleep at the wheel as our budget gets eaten alive by these contrived schemes. But they don’t worry because the average worker will still go to work, pay his tax for the rest of his working life and remain blindly ignorant

John Abernethy
Clime Investment Management Limited”

Article for AFR – The Franking Debate

“The ferocious debate regarding Labors proposed changes to franking rules has a degree of superficiality. The superficiality revolves around the lack of acknowledgement, at least by the Labor Party, that franking credits are an essential part of the management of all retirement funds.

Whilst it is easy to see that franking credits have enhanced the cash returns of SMSFs and thus supplemented their pensions and maintained their capital for longer; it is less obvious how franking has done the same for pooled super funds – Industry, Retail and Corporate Funds.

Since their inception, the franking rules have allowed tax that is payable to be offset by the franking credits received. In SMSFs the credits generally accrue to just one or two members. In pooled funds, the credits are earned by thousands of members to offset the tax payable inside the fund of thousands of members.

In pooled funds, accumulation members (with 15% notional tax) are blended with pension members (with no notional tax). The franking credits of the pension member – which could be cash rebates – are used to offset the tax payable by the fund for accumulation members. The fairness of this and the amount of tax minimized is rarely investigated. The Labor Party proposal to stop franking cash rebates keeps the tax break going for pooled funds. It also allows the benefit to be used as a tax offset for wealthy individuals inside and outside super. The superficiality of the debate Is clear.

Put into perspective, the franking debate should become a background issue for a more significant debate focused on the desired outcome for Australia’s retirement income or superannuation policy. But do we have a desired outcome by which we can measure the success or otherwise of our superannuation system?

In my view, we don’t and that is why the proposed changing of franking rules outside a retirement policy framework review is dangerous. In my view, the new member for Wentworth, Karen Phelps, is correct to propose a moratorium on superannuation changes (which must include franking) until a proper and full review is undertaken.

So what could be a desired outcome for our national retirement income policy? In my view, it should be directed towards and measured against our nations desire to have all retired Australians living with a reasonable standard of living supported by a pension system which creates a safety net for everybody.

Today most retirees enter retirement with less than $300k in retirement funds. Women are much worse off than men. Retired renters are much worse off than homeowners. Those who had interrupted working lives are much worse off than those who didn’t. Disturbingly over 70% of retirees claim a full or part pension upon retirement. This is all the result of our individual focused account based superannuation system.

Given those observations, we must question the integrity or logic of our account based superannuation system which is not properly positioned within a clear outcome based national pension scheme. That is another reason why the Labor franking policy needs to be stalled and addressed inside a proper restructuring of our retirement policy.

Today Australia has over $2.7 trillion in superannuation funds and yet this year the budget will still pay out about $60 billion in Commonwealth aged pensions. Our nation has done remarkably well at saving, but we have no sense as to whether those savings are working in the most efficient and sensible way.

Thus I ask this – can the Australian Parliament please create a National Retirement Commission as a matter of urgency to determine and therefore recommend the appropriate structure for the best national retirement scheme. Franking changes if appropriate can and should wait until that is done.

John Abernethy
Clime Investment Management Limited”

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16 Responses to “BHP buyback and franking debate”

  1. Ian Perren says:

    You have not mentioned those retirees outside of superannuation pensions who have a annual income of approx. $30,000 and will lose about $6500.00 in franking credits. The new big end of town !!!.

  2. Howard Elton says:

    As an advisory stockbroker with many clients holding BHP in their Super Funds (many in Pension mode) I believe I would be derelict in not advising these clients to participate in the BHP Off Market Buy-back.

    I recently gave a talk on Super to a U3A group ( in a leafy Melbourne suburb) and surprised most attendees that ~70% of retirees depend totally or in part on the Age Pension.

    Clearly denial of franking credit refunds will disadvantage self-funded persons with moderate assets.

  3. Aussiebrian says:

    Thank you John Abernathy, I have heard you speak on a number of occasions and I can always rely on you to cut through to the “bones” of the issue. I hope Felps can rally enough support to ensure no more knee-jerk reactions/policies on Superannuation and that your call to look at all aspects on Franking Credits in the context of Superannuation and retirement is taken up.

  4. Franco Costa says:

    Hi John,
    I want to commend you on your comments regarding the BHP buyback and the franking credit debate and to add Karen Phelps comments make good sense.
    This may be a time when we are getting some common sense in politics, this may be the start of something sensible.
    You have described these issues in a way that the average person can understand without all the bs.
    Well done,
    Franco Costa

  5. Trevor Ridgway says:

    John………… YOU think that anyone is even listening ?
    ASIC was EVIDENTLY “asleep at the wheel” while the BANKING RORTS occurred
    APRA doesn’t seem to have ANY beneficial effects and at all
    TREASURY seems to have more on it’s platter than it can handle !
    These are ALL HIGHLY PAID OFFICIALS who it seems are ineffective and
    I admire your particular stance on the FRANKING CREDITS situation ,
    especially as it relates to SUPERANNUATION , BUT I fear that it is all
    “falling on deaf ears” John !
    Regards , Trevor Ridgway.

  6. Bruce Derrick says:

    Yet another commonwealth government quango is most certainly not needed. Rather a few politicians with (1) a brain & (2) a conscience would be helpful.
    Surely the present crop would understand that existing SMSF’s in pension mode should not be messed with, no different to age pensioners etc. though sadly I have little confidence that any of them in Canberra are or will become, anytime soon, interested in doing anything other than feather their own nest at the expense of others

  7. Ian Kilpatrick says:

    If the franking credit regime proposed by Labor is to be adopted surely the fairest way to ensure everybody is treated the same is to make all superannuation funds SMSFs, industry retail etc. segregate each fund into accumulation and pensions funds with the following rules:-
    Accumulation:- 15% contribution tax, 15% earnings tax with full franking credits offset and no excess franking credit refund.
    Pension:- No tax on earnings and no franking credits refund.
    No transfer of franking credits between the segregated funds.

    At present anyone in pension mode in anything but an SMSF is contributing to the income of the members in accumulation mode. Maybe this is why the industry funds show such good returns.

  8. John Glen says:

    The points you make are sound, to my view. However the franking credit element available to members in a pension phase is one of the few concessions available. Depending on ones view on who is the ultimate owner of company tax paid, the company or the equity holder, one view can be that the ATO has held the equity owners tax, paid in advance (and possible never claimed as dividends generally are less than taxable company profit) without paying interest on the advanced payment. The BHP and Rio buyback structures partially remedy this, but in a technical way that has the distortions you point out. A forlorn concept – Australia aligns with most other countries by making superannuation pension phase payments additive to other income for an individual for annual tax purposes. Keating choose to not accept this option
    I have a view at variance to yours, higher payout ratios be in place, but capital for company expansion should partially be raised from shareholders rather than retained earnings. Such an approach would reduce an accumulation of franking credits and would require company directors to present a convincing case to shareholders -more onerous than to fund expansions from retained earnings.

  9. Alex Geels says:

    As usual, a very well constructed, researched and logical response from John Abernethy on both these issues. Probably why Canberra and the next (Labor) government will dismiss. My smsf was set up, under the then current rules, with costly professional help, 6 years ago, when I retired at 66. Past and intended future rule changes to super will create dark clouds to my strategy and income (20% reduction). It is totally unfair to remove franking credit refunds, as will be the outcome with my moderate smsf balance, with the stroke of a pen. Surely the changes should be grandfathered or, as a minimum, phased in over say a 5 year period. Hopefully the cross benches and Senate will see sense, because the current government are worryingly and strangely silent on the matter .

  10. Henry Ringwood says:

    Both letters are excellent contributions to the debate.
    I agree that the contrived loss is a rort.
    Why not a massive fully franked dividend and then a rights issue if capital has to be replenished?
    You can’t blame BHP however if the law allows them to do what they are doing.
    I hope the ALP people a considering the letters. Perhaps they should be sent to the shadow Treasurer.

  11. Greg Marusic says:

    Another excellent contribution from John Abernathy – pity we haven’t got someone with his brainpower and wisdom as the benevolent dictator of Australia.I’ve always thought of Australia as the lucky country, but I’m starting to worry that going forwards the lightweight cretins running our government and major corporations are not up to the new challenges that face our country in an emerging New World Order.

  12. Rod says:

    Insightful & interesting. An overhaul maybe a fairer option.

  13. Don Kohlhagen says:

    Your comment about the theft of franking credits from retired members of pooled funds and the benefit given to those in accumulation phase is spot on and is rampant in industry (union dominated) funds. One of the reason we would not leave any money in an industry fund upon retirement. In our SMSF we received the benefit, not someone unknown to us!

  14. john cameron stout says:

    Hi John
    Yes well written, but not only is super now not worth having but both major political parties have got themselves covered in so much fix it now plaster that they are no longer able to see the wood for the trees. The whole of governing needs a revisit.

  15. Tom says:

    As a West Australian I cannot help but notice that the example used by John is largely in this state and is an extension of his advocacy for excess taxes to be levied on the West, mostly for the benefit of east coast traffic decongestion and infrastructure projects, both of which drive up house prices and then require more infrastructure to solve the problem. If he gave more examples, of which there are many, where buybacks have distorted the tax system then he would be more credible. I would say that only West Australians believe in the Federation. All other states think it is simply a milk cow.

  16. John says:

    I agree with John Abernethy’s concerns entirely. Additionally, however, the Labor Party may be exposed to a class action in the event the party does not or is unable to implement their policy on franking credits, as they have tabled, if they gain power. The policy tabled is concise on who can and cannot any longer receive franking credits in cash, with an operational commencement date set as of 28 March 2018, even though tabled while not in office. This has meant that the Labor Party, either intentionally or unintentionally, has directly manipulated the markets to the detriment of many parties and retirees and compounded the effect as there are no overall grandfather provisions. This lack of grandfathering provisions has been reaffirmed by Labor on several recent occasions.

    The ability for a major political party to table such policy arrangements has to be regarded by affected parties, investors and retirees, to have full credence, otherwise the Labor Party can have no standing. As a consequence, many investors and retirees affected by the policy have suffered angst, confusion and cost. It has also raised concern going forward for some resulting in a need to restructure financial arrangements at further cost to try and mitigate the effects of such a policy. Some of these people are septuagenarians, octogenarians or older. I and my wife fall into one of these categories.

    There is the possibility that the Labor Party may now or later change its approach on this policy for whatever reason, or there is an inability to implement the policy when in power for other reasons such as constitutional. The rights for redress against the Labor Party by those parties who bore the angst, confusion and costs must then be more compelling than those as highlighted by the Royal Commission on the Banks for giving inappropriate advice to its customers and treated accordingly.

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