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
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
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.
Clime Investment Management Limited”