Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 481

The proposal on capital raisings and franking is misguided

The Government currently proposes two changes to legislation involving franking credits. 

1. Preventing franked distributions when funded by certain capital markets raisings

Federal Treasury recently completed a consultation process on a Bill that amends taxation law to prevent certain franked distributions that are funded by capital raisings. In its background document, Treasury says this on imputation:

"The imputation system has the effect of allowing income tax paid by Australian corporate tax entities to be taken into account when determining the taxation of their resident members on the distributed profit of the entity. When an Australian corporate tax entity distributes profits to its resident members, it can also pass on a credit for income tax it has paid. This is done by franking the distribution ... If an entity is unable to frank a distribution and makes an unfranked distribution instead, the receiving entity includes the amount of the distribution in its assessable income, but it is not entitled to a tax offset."

The Bill proposes an integrity measure to prevent this distribution of franking credits where a distribution to shareholders is funded by particular capital raising activities, such as when distributions are made outside or additional to the company's normal dividend cycle.

2. The 2022 Budget clamp down on off-market buybacks

No specific details other than to “align the treatment of off-market buybacks with on-market buybacks” have been announced, but it is expected that no franked payments will be allowed as part of an off-market buyback (that is, it will be a capital return).

The following article, written as a submission to Treasury before the Budget announcement, explains why the first proposed change above is wrong but the second proposal has merit.

***

1. The proposed legislation [the first item above] on disallowing franking on certain capital raisings is misguided and addresses the wrong problem. It also unnecessarily complicates tax legislation via the discretion given to the ATO to determine when franking of dividends involved is to be disallowed. It is not the (near) simultaneous raising of equity to finance a distribution to shareholders which is the problem. It is the streaming of dividends which should be the concern.

2. A much simpler solution to the problem of preventing streaming of franking credits (with its inherent cost to government tax revenue) would be to abolish the ability of companies to undertake what we have called TOMBS (Tax-driven Off Market Buybacks). Companies wishing to make returns of capital (one component of TOMBS) would still be able to do so via buybacks where the amount involved is treated solely as a return of capital. Companies wishing to pay franked dividends which would reduce their franking account balances (FABs) would be able to do so by way of a special franked dividend paid pro-rata to all shareholders.

There is nothing inherently wrong with raising cash needed to do so by issuing new equity. Under the imputation tax system, company tax paid is meant to be a prepayment of investor level tax, and unused franking credits in a company’s FAB are a withholding of tax credits due to shareholders.

3. The original ATO Taxpayer Alert (TA 2015/2) from which this proposed legislation stems, posed the problem as being the linking of an equity capital raising with:

“[a]t a similar time …, the company makes franked distributions to its shareholders, in a similar amount to the amount of capital raised. This may occur as a special dividend or through an off-market buy-back of shares, where the dividend forms part of the purchase price of the shares.”

The ATO forecast that implementing a ban on these practices (as proposed in the draft legislation) would resulting in a saving to tax revenue in the order of $10 million p.a.

4. This is a trivial amount compared to the cost to tax revenue arising from the use of TOMBS. In our research1 on TOMBS, we estimated that in 2018 the tax revenue cost from TOMBS conducted in that year alone to be in the order of $2 billion. Recent calculations we have made for the years 2019 and 2020 (years which had many fewer TOMBs, partly due to the COVID pandemic in 2020) suggest that the tax cost for those two years together was in the order of $500 million.

These costs arise regardless of whether or not the company needs to undertake an equity issue to finance the cash outflow involved – indicating that the focus of the legislation on the 'near simultaneous' equity raising is addressing a trivial, rather than the real, problem.

5. The ATO Taxpayer Alert also refers to concerns over special franked dividends where the cash outflow is essentially financed by a cash inflow from a separate equity raising. This is misguided. For example, a company may have a positive franking account balance, be legally able to pay a dividend, but not have cash on hand. There is nothing inherently wrong with raising cash via an equity issue to pay a franked dividend. For example, the company may have had a period during which it was profitable and paying tax, but adopting a low dividend payout ratio due to opportunities to profitably invest the available cash flow. Subsequently it may find itself in a position where it is profitable and 'asset rich' but 'cash poor' and wishing to reward existing shareholders for forgoing past dividends and associated franking credits. There is nothing inherently wrong with raising cash via an equity issue to pay a franked special dividend.

6. We conclude that the proposed legislation [proposal one above] is inferior to an alternative course of action which:

a. Effectively bans TOMBS by legislating that off-market share buybacks involve only a return of capital and no dividend component. (This is more consistent with practices found in other jurisdictions. The inclusion of a dividend component is solely an artifact of dividend imputation and willingness of the ATO to allow a franked dividend component).

b. Does not place unnecessary restrictions on the use of special franked dividends by companies – particularly by not precluding simultaneous equity raisings.

 

Submission to the Treasury Consultation, September 2022 by Christine Brown, Emeritus Professor of Finance, Monash University and Kevin Davis, Emeritus Professor of Finance, The University of Melbourne.

1 Christine Brown and Kevin Davis “Tax-driven Off Market Buybacks (TOMBs): Time to Lay them to Rest” Australian Tax Forum, 35, 2, Jun 2020: 232-257.

 

Christine Brown and is Emeritus Professor of Finance at Monash University and Kevin Davis is Emeritus Professor of Finance at The University of Melbourne. Kevin’s free e-text reference book 'Bank and Financial Institution Management in Australia' is available on his website. Kevin was also a member of the Financial Systems Inquiry ('The Murray Report') in 2014.

 

2 Comments
John
October 29, 2022

I worry that any playing with Franking dividend policy is the thin edge of the wedge. I have said before govt means tested the pension and the will "means test" super. I mean by that they "will find a way to get more or give less". I can't believe some people don't see the big picture.

JOHN L M
October 26, 2022

Thank you The biggest problem with the elimination of franking credits from dividends where it is deemed to have been in any part due to a capital raising [as arbitrarily at the complete discretion of the ATO] is that it was drafted in 2016, never enacted, never then intended to be retrospective, and still has the original date of 19/12/2016. It is the retrospectivity now included that is potentially an entrapment of innocent taxpayers, who paid as required under existing legislation. If the franking credits already included are reversed, all super funds, all university endowments, research insitutions and major charities [cancer funds, heart foundation, flying doctor, red cross etc] , with investments eg from bequests and donations; private schools; land councils etc., would need to be reassessed and pay back franking credits. And ALP could not play favorites as in 2019 proposals re franking -- e g exempt Industry super funds while penalising SMSFs. If the actions are deemed now retrospectively to be illegal, the government could not then authorize certain institutions to behave illegally

 

Leave a Comment:

RELATED ARTICLES

Should we change the company tax rate?

Retained profits a conspiracy against super and pension funds

The myth of Australia’s high corporate tax rate

banner

Most viewed in recent weeks

Simple maths says the AI investment boom ends badly

This AI cycle feels less like a revolution and more like a rerun. Just like fibre in 2000, shale in 2014, and cannabis in 2019, the technology or product is real but the capital cycle will be brutal. Investors beware.

Why we should follow Canada and cut migration

An explosion in low-skilled migration to Australia has depressed wages, killed productivity, and cut rental vacancy rates to near decades-lows. It’s time both sides of politics addressed the issue.

Are LICs licked?

LICs are continuing to struggle with large discounts and frustrated investors are wondering whether it’s worth holding onto them. This explains why the next 6-12 months will be make or break for many LICs.

Australian house price speculators: What were you thinking?

Australian housing’s 50-year boom was driven by falling rates and rising borrowing power — not rent or yield. With those drivers exhausted, future returns must reconcile with economic fundamentals. Are we ready?

Retirement income expectations hit new highs

Younger Australians think they’ll need $100k a year in retirement - nearly double what current retirees spend. Expectations are rising fast, but are they realistic or just another case of lifestyle inflation?

Welcome to Firstlinks Edition 627 with weekend update

This week, I got the news that my mother has dementia. It came shortly after my father received the same diagnosis. This is a meditation on getting old and my regrets in not getting my parents’ affairs in order sooner.

  • 4 September 2025

Latest Updates

Shares

Why the ASX may be more expensive than the US market

On every valuation metric, the US appears significantly more expensive than Australia. However, American companies are also much more profitable than ours, which means the ASX may be more overvalued than most think.

Economy

No one holds the government to account on spending

Government spending is out of control and there's little sign that Labor will curb it. We need enforceable rules on spending and an empowered budget office to ensure governments act responsibly with taxpayers money.

Retirement

Why a traditional retirement may be pushed back 25 years

The idea of stopping work during your sixties is a man-made concept from another age. In a world where many jobs are knowledge based and can be done from anywhere, it may no longer make much sense at all.

Shares

The quiet winners of AI competition

The tech giants are in a money-throwing contest to secure AI supremacy and may fall short of high investor expectations. The companies supplying this arms race could offer a more attractive way to play AI adoption.

Preparing for aged care

Whether for yourself or a family member, it’s never too early to start thinking about aged care. This looks at the best ways to plan ahead, as well as the changes coming to aged care from November 1 this year.

Infrastructure

Renewable energy investment: gloom or boom?

ESG investing has fallen out of favour with many investors, and Trump's anti-green policies haven't helped. Yet, renewables investment is still surging, which could prove a boon for infrastructure companies.

Investing

The enduring wisdom of John Bogle in five quotes

From buying the whole market to controlling emotions, John Bogle’s legendary advice reminds investors that patience, discipline, and low costs are the keys to investment success in any market environment.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.