The danger of Labour’s new postage credit proposal

We all remember the 2019 Franking Credit proposals which contributed significantly to the Labor Party’s electoral defeat and helped bring about the Scott Morrison ‘miracle’. A major problem with this proposal was that it had many unintended consequences. The same can be said for the new Labor Party proposal to stop the payment of franked dividends funded by capital raising.

Paying company dividends

Simply put, before a company can pay a dividend, it must:

  • Make profit and
  • Pay the tax.

The after-tax amount is credited to retained earnings and a dividend may be paid to shareholders. However, there may be times when a company has spent its profits on operating the business and therefore does not have the cash to pay a dividend. In such circumstances, when directors consider the payment of dividends important, they may seek to raise funds by borrowing money or issuing more capital.

According to Treasury documents, the new government proposal aims to:

“…prevent companies from attaching franking credits to shareholder distributions made outside of or in addition to the company’s normal dividend cycle, to the extent that the distributions are funded directly or indirectly by raising of capital which results in the issue of new participations.

At first glance, many would think this seems reasonable. However, as with many tax laws, the problem lies in the details and the practical implications.

Devil in the detail

The proposal will make the job of an entrepreneur more difficult given its wide application. Paragraph 1.33 of the explanatory documents specifies the following regarding a capital increase:

The relevant purpose need not be the sole, dominant or main purpose, only that it be more than incidental to another purpose.

In other words, if the capital raising can be said to be related to the dividend, then the entire dividend could be considered unstamped.

Anyone who has watched listed companies operate will find that their capital needs are constantly changing. One minute they could be paying dividends and returning capital to shareholders. The next minute, due to a market change or business challenge, they may need to borrow money or raise capital to shore up their balance sheet. A few months later, they might again be able to return money to shareholders.

The example of Westpac

An example cited in the press in recent weeks is the November 2019 dividend paid by Westpac. A frank dividend of 80 cents was issued the same day the bank announced a $2.5 billion fundraising. The funds from the fundraising were received before the dividend was paid. But under the government’s proposal, a dividend payment must be unfranked if it is funded by raising capital, even if the company has franking credits available for distribution.

Will Westpac be caught up in this proposal, which is backdated to 2016? I think the answer is “maybe”. There are arguments for and against. What is clear, however, is that had they not paid the dividend, the capital raising might have been less.

But was Westpac making an artificial arrangement? Has the bank committed wrongdoing that must stop?

I think most would agree that Westpac did nothing wrong. Banks have always balanced the payment of franked dividends to shareholders with the need to raise capital at certain times to secure their balance sheets.

This dilemma that Westpac directors face if this new legislation is introduced will be repeated in boardrooms across Australia. There should be nothing wrong with a company raising capital to strengthen its balance sheet. There should also be no harm in a company paying out retained earnings to shareholders in the form of fully franked dividends.

A recipe for worse results

Giving the tax office discretion to question directors’ motives is likely to lead to poorer results because decisions are made to meet legislative requirements rather than to meet the interests of the company and shareholders.

The Treasury document states that the purpose of these changes is to:

“…prevent entities from manipulating the charging system to gain access to postage credits”.

It should be noted that there is already strong anti-avoidance legislation in place to stop manipulation without impinging on corporate board decision-making.

It is clear that governments need to be vigilant when it comes to tax legislation as companies seek to exploit loopholes. However, I understand that the “problem” that this legislation is trying to solve is not generalized. As a result, there is concern that companies and shareholders will be worse off without any discernible improvement in taxation.

Matthew Collins is a director of Consulting Keystone Pty Ltd and specializes in providing superannuation tax, inheritance tax and structural advice to high net worth individuals and their families. This article is general information and does not take into account the situation of an individual investor. It is based on a current understanding of related legislation which may change in the future.

About Kristina McManus

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