Home / Legislation / Proposed changes to off-market share buybacks rile franking system advocates

Treasury has released for public consultation draft legislation aimed at closing a tax loophole for off-market share buybacks, prompting renewed fears over the future of franking credits despite assurances that mum-and-dad investors will not be affected.

Following up on a policy change outlined in its October budget, the federal government has released proposed legislation aimed at closing a tax “loophole” it says large companies are exploiting to preference institutional shareholders through off-market share buybacks, costing taxpayers millions.

The draft legislation, which Treasury released November 17 for public consultation through December 9, would resolve inconsistencies in the tax treatment of on-market and off-market buybacks that currently allow listed public companies to buy back shares at a discount using franking credits.

Following the budget’s surprise revelation that the changes were coming, critics have accused the Labor government of seeking to dismantle Australia’s franking system – also known as dividend imputation – and breaking election promises, while proponents say a re-examination of the tax-effective loophole is warranted, especially given the budget is in structural deficit. 

In a speech to the Institute of Public Accountants (IPA) prior to the release of the draft legislation, Assistant Treasurer Stephen Jones said the move was “about system integrity and fairness” and emphasised that the proposed changes were not directed at the franking credits system itself. He vowed “mum-and-dad investors will continue to receive their franked dividends” and be able to participate in buybacks.

‘Very big budget impact’

Under current tax law, a company can buy shares back from shareholders off-market at a discount by offering franked dividends crediting the seller for the tax the company has already paid on its profits, generally 30 per cent. Shareholders taxed at a lower rate, such as superannuation funds, can then use the refundable franking credits and pay lower capital gains tax.

The government says the system – which is in use only in Australia – inequitably favours certain classes of shareholders and causes leakage in tax revenue that costs taxpayers $200 million a year. To close the loophole, the proposed legislation would amend the Income Tax Assessment Act of 1936 to provide that no part of the purchase price for off-market share buybacks is considered a dividend, bringing their tax treatment in line with that of on-market buybacks.

The proposed legislation “ends an unintended incentive for corporates to buy back shares off-market” that ultimately hurts taxpayers and most shareholders, Jones said in announcing the measure.

“Dividend imputation is there to give companies a way of allocating tax credits to their shareholders when they distribute franked dividends,” he said. “It is not there for corporations to exploit the tax treatment, at taxpayer expense, of off-market share buybacks.”

While he noted that such buybacks are relatively rare, Jones said they nonetheless have a “very big budget impact”, with deals often amounting to billions of dollars. He cited as examples BHP’s 2018 off-market buyback totalling $8.5 billion, Commonwealth Bank’s $7 billion deal from 2021 and a $3.7 billion buyback conducted by Westpac earlier this year, all discounted from market price.

Steady pushback

The move to reform the off-market buyback loophole enjoys support from some stakeholders, including the IPA, but is likely to face continued opposition from others such as the SMSF Association that view it as an attack on the franking system and, ultimately, retirees.

Geoff Wilson (pictured), founder of fund manager Wilson Asset Management and a strong critic of government attempts to change the dividend imputation system, has said the proposed amendments are “a clear backdoor attempt to dismantle the franking system”, which he calls a “key pillar of the Hawke-Keating economic reforms that have helped underpin three decades of recession-free economic growth in this country”.

Speaking with The Inside Investor, Wilson said the draft legislation does not address concerns the budget announcement prompted over the future of the franking system. Rather, the Labor government is going back on pre-election statements it made on the issue and effectively seeking to “neuter” the dividend imputation system.

“Both [Prime Minister Anthony] Albanese and [Treasurer Jim] Chalmers said before the election that they wouldn’t do anything to the franking credit regime, and within the first year they are breaking those promises,” Wilson said. The Labor party previously attempted to alter the system by addressing the ability of individuals to use franking credits, costing it the 2019 election, he said, characterising the new proposal as a “retirement tax 2.0” that merely revives that same flawed approach.

“What they’re trying to do now is stop the companies from paying fully franked dividends by changing off-market buybacks and stopping them from raising capital associated with fully franked dividends,” he said, referring to a separate proposed prohibition on the use of capital raisings to fund excess franking credit distributions on companies’ balance sheets.

“Either it’s malicious and they knew they were going to do this all along and simply lied to the Australian people before the election, or the Treasury Department has pulled the wool over their eyes,” Wilson said. “For years, [former Labor Prime Minister] Paul Keating has been warning that the Treasury doesn’t understand the incredible benefits the franking system gives to Australia.”

According to Wilson, the proposed legislation will have significant “unintended consequences” for the Australian economy, as it will result in less investment in Australian companies and send investment funds offshore. “It will negatively affect the banking system, significantly increase the cost of capital and increase the volatility corporates are facing, and all Australians will suffer.”