Mon, Mar 07, 2011 6:24 PM
By Stephen Bartholomeusz
BHP Billiton lodged the documentation for its proposed $US5 billion off-market buy-back with the ASX today. The buy-back, announced last month, has already attracted the usual criticism.
During the financial crisis the debate about the equity of off-market buy-backs died away, for the obvious reasons that there weren’t any because companies were conserving their capital. Woolworths conducted one last year, but BHP Billiton’s will be easily the largest and more than twice the size of the $US2.25 billion buy-back it conducted in 2006.
The Australian Centre for Financial Studies’ Kevin Davis, in a discussion paper released on Friday, said that between 1996 and 2008 there were more than 80 off-market buy-backs that returned about $27 billion of cash to participating shareholders.
It was towards the end of that period that the volume of criticism of them mounted to the point that the federal government directed the Board of Taxation to review the arrangements for buy-backs in 2009. While the board presented Peter Costello with recommendations for reform that would have materially reduced their appeal, nothing happened.
The BHP Billiton buy-back will be conducted as a tender. Essentially shareholders compete to be involved by bidding at a discount to the market price.
They are prepared to sell their shares for less than the market price because when they are paid for their shares they are deemed to have received a combination of a (small) capital amount and a franked dividend. Thus they not only get franked income but a significant capital loss to set against profits elsewhere.
That makes the buy-backs particularly attractive to shareholders with zero or low tax rates, like superannuation funds or charities, and quite unattractive to shareholders on the top marginal tax rate.
Professor Davis summed up the arguments against off-market buy-backs by saying that the tax-based discrimination against shareholders on high tax rates had led to concerns about the equitable treatment of shareholders and the consistency of the buy-backs with Corporations Law requirements that all shareholders should be treated equally.
"In effect, the argument is that valuable franking credits are being siphoned to one group of shareholders to the detriment of others."
As Professor Davis acknowledged, however, there are benefits for non-participating shareholders because the reduced capital base means enhanced performance statistics – earnings per share, cash flow per share, asset backing and return on equity. In effect their share of the company’s earnings and assets is increased and that ought to be reflected in a relatively higher share price.
That led him to refer to the other big criticism of the buy-backs, that both participating and non-participating shareholders benefit at the expense of the taxpayer. Their critics refer to off-market buy-backs as taxpayer-funded rorts.
They are not that. Companies accumulate franking credits because they have paid tax. The objective of the dividend imputation system was to remove the previous double-taxation of profits at the corporate and individual levels.
The system, however, wasn’t and isn’t pure because it excluded non-Australian shareholders and contains prohibitions against the "streaming" of credits so that they can be devoted purely to Australian shareholders – there is significant wastage of the credits for local company taxes that have been paid.
The buy-backs are a mechanism for selling those excess credits to those who value them most, which in turn means that all shareholders, including foreign shareholders, will get some benefit from the excess credits being distributed. That wouldn’t happen if BHP Billiton had chosen to pay a special dividend rather than conduct a buy-back.
Whether it is the local shareholder versus the foreign shareholder, or low-tax rate shareholders versus those on the top marginal tax rate, and whether the talking point is dividends or buy-backs, the tax system means that any distribution or capital management program will have some inequitable aspects.
Buy-backs, because the participants tend to capitalise much of the benefit in the discounts they bid (in BHP’s case the discount can be up to 14 per cent) are probably more equitable for all shareholders than other forms of distribution.
That limit on the discount allowed has been imposed by the Australian Taxation Office, which impose (somewhat arbitrarily) a number of guidelines for what it will accept in buy-backs when Commonwealth Bank was a little too aggressive in structuring a $650 million buy-back in 1997. The details of individual buy-backs are negotiated with the ATO.
If buy-backs were a rort, one assumes that the ATO would have done something about them, or that successive governments would have acted on the recommendations of the Board of Taxation and made them less attractive. It is not as though the government, the ATO and the Australian Securities and Investment Commission are unaware of the controversies.
In fact the existence of the franking credits says that Australian company taxes have been paid and all the buy-back does is bring forward the ability to use excess credits and deploy them more efficiently and to the benefit of the entire shareholder base – Australian and foreign – that, given they are an asset of the company, owns them.
Professor Davis says the revival of interest in the buy-backs means the tax arrangement should be clarified and debates about equitable treatment of shareholders resolved. Perhaps he’s right, although the popularity and success of the buy-backs and the reality that the ATO and governments have okayed them for more than a decade and a half would suggest there’s nothing much to be clarified or resolved.
During the financial crisis the debate about the equity of off-market buy-backs died away, for the obvious reasons that there weren’t any because companies were conserving their capital. Woolworths conducted one last year, but BHP Billiton’s will be easily the largest and more than twice the size of the $US2.25 billion buy-back it conducted in 2006.
The Australian Centre for Financial Studies’ Kevin Davis, in a discussion paper released on Friday, said that between 1996 and 2008 there were more than 80 off-market buy-backs that returned about $27 billion of cash to participating shareholders.
It was towards the end of that period that the volume of criticism of them mounted to the point that the federal government directed the Board of Taxation to review the arrangements for buy-backs in 2009. While the board presented Peter Costello with recommendations for reform that would have materially reduced their appeal, nothing happened.
The BHP Billiton buy-back will be conducted as a tender. Essentially shareholders compete to be involved by bidding at a discount to the market price.
They are prepared to sell their shares for less than the market price because when they are paid for their shares they are deemed to have received a combination of a (small) capital amount and a franked dividend. Thus they not only get franked income but a significant capital loss to set against profits elsewhere.
That makes the buy-backs particularly attractive to shareholders with zero or low tax rates, like superannuation funds or charities, and quite unattractive to shareholders on the top marginal tax rate.
Professor Davis summed up the arguments against off-market buy-backs by saying that the tax-based discrimination against shareholders on high tax rates had led to concerns about the equitable treatment of shareholders and the consistency of the buy-backs with Corporations Law requirements that all shareholders should be treated equally.
"In effect, the argument is that valuable franking credits are being siphoned to one group of shareholders to the detriment of others."
As Professor Davis acknowledged, however, there are benefits for non-participating shareholders because the reduced capital base means enhanced performance statistics – earnings per share, cash flow per share, asset backing and return on equity. In effect their share of the company’s earnings and assets is increased and that ought to be reflected in a relatively higher share price.
That led him to refer to the other big criticism of the buy-backs, that both participating and non-participating shareholders benefit at the expense of the taxpayer. Their critics refer to off-market buy-backs as taxpayer-funded rorts.
They are not that. Companies accumulate franking credits because they have paid tax. The objective of the dividend imputation system was to remove the previous double-taxation of profits at the corporate and individual levels.
The system, however, wasn’t and isn’t pure because it excluded non-Australian shareholders and contains prohibitions against the "streaming" of credits so that they can be devoted purely to Australian shareholders – there is significant wastage of the credits for local company taxes that have been paid.
The buy-backs are a mechanism for selling those excess credits to those who value them most, which in turn means that all shareholders, including foreign shareholders, will get some benefit from the excess credits being distributed. That wouldn’t happen if BHP Billiton had chosen to pay a special dividend rather than conduct a buy-back.
Whether it is the local shareholder versus the foreign shareholder, or low-tax rate shareholders versus those on the top marginal tax rate, and whether the talking point is dividends or buy-backs, the tax system means that any distribution or capital management program will have some inequitable aspects.
Buy-backs, because the participants tend to capitalise much of the benefit in the discounts they bid (in BHP’s case the discount can be up to 14 per cent) are probably more equitable for all shareholders than other forms of distribution.
That limit on the discount allowed has been imposed by the Australian Taxation Office, which impose (somewhat arbitrarily) a number of guidelines for what it will accept in buy-backs when Commonwealth Bank was a little too aggressive in structuring a $650 million buy-back in 1997. The details of individual buy-backs are negotiated with the ATO.
If buy-backs were a rort, one assumes that the ATO would have done something about them, or that successive governments would have acted on the recommendations of the Board of Taxation and made them less attractive. It is not as though the government, the ATO and the Australian Securities and Investment Commission are unaware of the controversies.
In fact the existence of the franking credits says that Australian company taxes have been paid and all the buy-back does is bring forward the ability to use excess credits and deploy them more efficiently and to the benefit of the entire shareholder base – Australian and foreign – that, given they are an asset of the company, owns them.
Professor Davis says the revival of interest in the buy-backs means the tax arrangement should be clarified and debates about equitable treatment of shareholders resolved. Perhaps he’s right, although the popularity and success of the buy-backs and the reality that the ATO and governments have okayed them for more than a decade and a half would suggest there’s nothing much to be clarified or resolved.
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