Govt’s franking regime changes questioned

Despite minimal industry opposition, DNR Capital has raised concerns about the government’s new Treasury Laws Amendment Bill related to franked dividends funded by capital raisings.

Scott Kelly, Portfolio Manager for the DNR Capital Australian Equities Income Strategy, said the legislation, aiming to save the Budget $600 million over the next four years, will align the tax treatment of off-market share buybacks with on-market share buybacks.

“Historically large companies have often raised capital from shareholders through fully underwritten capital raisings and then paid out all that money raised as a franked dividend,” Kelly said.

“But the government wants to clamp down on this move so that a company will not be able to pay out franked dividends that are directly or indirectly funded by capital raising. And whilst, at face value, that may not seem unreasonable, we note a number of concerns about unintended consequences.

“The first problem is that the proposed test to determine whether companies can pay out fully franked dividends observes an established practice of paying dividends over time. This potentially puts startups at a disadvantage given they tend not to pay out dividends in the first few years of operations.

“Secondly, the proposal appears to capture a dividend reinvestment plan, which is also a form of capital raising, and this potentially could result in shareholders losing franking credits over time.

“And finally, companies will still be able to fund dividends by taking on debt. This potentially puts small companies at a disadvantage given their limited access to capital markets relative to larger companies.”

Kelly said the proposed changes could lower the effectiveness of the franking system in Australia, with self-funded retirees and retail investors believed to be the most effected once the legislation is passed.

“For companies, under the new proposals, there’s the increased risk that franking credits will become permanently trapped within the companies,” he said.

“And there are also broader implications for the economy upon which Australia’s franking regime has supported investment and growth over time.

“We expect that franking rich companies will review and possibly increase dividend payout ratios and potentially also look to pay out special dividends more regularly.”