Corporate measures

The Federal Government announced proposed changes to the income tax treatment of off-market share buy-backs, which will align the tax treatment with on-market share buy-backs. Targeted towards superannuation fund investors, this measure effectively removes access to refundable franking credits on these transactions.

Change in treatment of off-market share buy-backs In a somewhat surprising move, given the political sensitivity of refundable franking credits, the Federal Government will target investors of listed companies who undertake off-market share buy-backs in a measure that is anticipated to save $550 million over the next four years.

Presently, the tax law distinguishes between a share buy-back made in the ordinary course of trading on an official exchange (on-market buy-backs), and all other share buy-backs (off-market buy-backs).

Under the current rules, a company that undertakes an off-market share buy-back is required to allocate the buy-back proceeds received by the shareholder between two components, a dividend component (which can be franked), and a capital component. This split is often based on the relative composition of the company’s retained earnings and paid-up share capital. However, where a buy-back occurs on-market, no part of the purchase price is taken to be a dividend. Instead, the company is required to debit its franking account.

Investors who may obtain a refund of excess franking credits, such as superannuation funds, retirees and charitable organisations, may have a preference to participate in an off-market share buy-back. Where the buy-back price is largely made up of the dividend component, the current rules also allow taxpayers to recognise a capital loss due to the reduced capital proceeds for capital gains tax purposes. As they are typically selective, investors that choose to participate in off-market buy-backs will generally obtain the greatest tax benefits.

Under the proposed measure, the tax treatment of off-market buy-backs by listed companies will align with on-market buy-backs. In other words, no part of the consideration for the off-market share buy-back will be taken to be a dividend and the company will be required to debit its franking account. Whilst the effective tax rate for an individual on the top marginal tax rate deriving a discount capital gain is similar to that when receiving a fully franked dividend (depending on the cost base of the shares), the changes would be expected to impact the investment returns of superannuation funds.

This is the second recently announced measure targeting franking credits derived by superannuation funds that invest in Australian listed companies. These measures appear to be contrary to the election promise of the Federal Government that stated they would not pursue the removal of refundable franking credits derived by superannuation funds.

If enacted, the measures will apply from 7:30pm on Budget Night (25 October 2022) and may result in the discontinuation of a number of off-market share buybacks currently being contemplated by listed companies.