Buyback changes won't dampen appeal
David Bushby, BRR Media
Mark Friezer, Partner, Taxation, Clayton Utz
We're speaking with Mark Friezer who's a partner in the taxation team with Clayton Utz in Sydney. Welcome to BRR Mark.
Mark, listed companies have been busy managing their excess capital with some 9 billion of share buybacks announced in the past year alone. However, the rules governing the tax treatment of those buybacks are now set to change with the release of draft laws last week which some commentators are saying will dampen their appeal for participating shareholders.
Yes David, well time will tell but I suspect that share buybacks will continue to be pretty attractive.
When you look at listed company share buybacks the real question that taxpayers have always had to ask themselves is, "Am I better off on an after-tax basis accepting the off-market buyback offer or should I simply sell my shares into the market?" Having regard to the way the buybacks are normally structured the answer has almost inevitably been that if you're a high marginal rate taxpayer then you can forget the buyback - you're better off just selling your shares on the exchange and getting the benefit of a discount capital gain.
It's always been a very different story for low margin rate taxpayers - in other words, individuals who aren't on the top rate, and particularly super funds. If they're in the accumulation phase they're paying 15% or indeed if they're in the pension phase, a super fund will actually only pay a zero rate of tax and the benefit of the off-market buybacks for those taxpayers has always been that the franking credits that they get to enable them to get refunds and they're also entitled to, generally speaking, a capital loss on the shares that are bought back.
So, against that background what's changed with these proposed new rules? Well the big change for listed companies is that share buybacks can't generate a capital loss so it is a negative but I don't actually think this will mean a lot for several reasons. When you crunch the numbers on buybacks that have been done you generally find that the excess between the proceeds you get from the buyback over what you would have got if you sold them on the market generally exceeds the amount of the capital loss benefit.
So in other words, the real reason for doing the buyback isn't driven by the capital loss. In the current stock market environment query whether taxpayers are really looking to generate capital losses anyway. I mean if my portfolio is representative of the others out there I think, you know, taxpayers generally have plenty of capital losses.
Realised or unrealised.
Well just looking also at the laws, they're also proposing to remove the current 14% cap on the discount at which listed companies can buy back their shares so why that change and what effect do you think that will have?
Well the 14% cap was criticised as being an arbitrary limit which unduly restricted the amount that shareholders of listed companies could tender their shares for under a tender buyback process. The rationale of the cap was that if the buyback price was too heavily discounted then the buyback would only ever apply to those low rate taxpayers I referred to and therefore you could stream the benefits artificially, that was the Tax Office view.
Now the reality is that most buybacks have been over-subscribed in the last few years and subject to scale back and probably one of the main reasons for that is there's been this artificial cap on the discount that's offered. So in other words, buyback pricing has been artificially inflated in a beneficial way for certain shareholders. Removing the cap means that listed companies can buy back their shares at a price which is now significantly less than the current share price. I think the real constraint is, therefore, a commercial one now. If a discount amount gets too great shareholders will simply sell their shares on the market.
It's a market mechanism that's going to regulate this and it's a market mechanism that's going to dictate where the tax benefits go and I think the Board of Tax which recommended this change a couple of years ago basically came to that conclusion. It's better to let the market work it out than artificially impose an arbitrary cap.
Well just in terms of buybacks we've seen a lot in recent times, do you see more buybacks happening through 2012 given the current state of markets?
Well I suspect that any buyback activity which would otherwise have occurred won't be negatively impacted by these changes. Look one thing I should point out David is that the changes that we're talking about here are in the form of an exposure draft, not even a bill yet, so they won't take effect till Royal Assent, in other words when the bill's passed through Parliament and that may not happen, you know, for several months yet.
But, as I said, the real negative in these rules is the abolition of the capital loss. I don't think that's a big thing. The rules also introduce some real positives that make it easier for companies to get these things away so that there's certain kind of tax avoidance rules that in the past a company has always had to go to the Tax Commissioner to get a class ruling to ensure that these rules didn't apply. Execution was very difficult for these transactions.
Now there's a safe harbour in these rules which says that provided the capital income split on the buyback is done in a certain way, there is no application of these anti-avoidance rules, so the procedure from the company's perspective should be simplified.
But look, in answer to your question, it seems to me most of the classic commercial reasons why you do a buyback are still there. Companies that have got strong balance sheets with healthy cash balances, the depressed share market means that it's still relatively cheap to buy back your stock, buybacks give you earnings per share benefits which of course enhance flagging share prices - all of those are classic reasons which have always been advanced for buybacks. Nothing has really changed as a result of these proposed new rules so in answer to your question, yes I think it will be a healthy market in 2012 for buybacks.
Yeah it certainly will, we'll keep a close eye on it and as you said, it is early days for these rules to take effect. We'll leave it there, and thanks again for your comments today Mark.
Thanks, a pleasure David.
That was Mark Friezer, a partner in the taxation team with Clayton Utz in Sydney. Listeners, if you have any questions for Mark, please email him on email@example.com.