Why franking credits policy is a two-horse horse race

This horse certainly needs to be scratched from the race. The “thoroughbred” proposal, on the other hand, has merit on grounds of both economics and equity.

Even ignoring the significant tax gains likely, these Tax-Driven-Off-Market-Buybacks (TOMBs, as we have called them), are unfair to those shareholders who do not participate. (There have only been about 60 to date, but of immense size, by large companies). As in many situations, the gains to a few are clear and conducive to lobbying, but the significant cost to the majority is less apparent. In the case of TOMBs, the non-participating shareholders are not compensated adequately for the “streaming” of franking credits to the zero and low-tax-rate participating shareholders.

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We have explained in an article in the Pearls and Irritations public policy journal that there is no reason as to why TOMBs should be allowed by the regulators, and that there is no apparent adequate justification for the ATO and the Australian Securities and Investments Commission permitting them to happen. The approval of these highly structured, artificial, financial transactions reeks of regulatory capture. In the absence of TOMBs, if a company wants to distribute excess franking credits, it can pay a special dividend. If it wants to return capital to shareholders it can do so via a normal share buyback.

Somehow, in the mid-1990s, the smart money managed to get the regulators to acquiesce to allowing TOMBs with their artificial structure which streams franked dividends to a subset of lucky shareholders at the expense of other shareholders and government tax revenue.

Hopefully the thoroughbred will stay the course and win the race – leading to the banning of TOMBs and not get nobbled by lobbyists. That would further strengthen the case for scratching the “nag”.

Christine Brown is emeritus professor at Monash University and Kevin Davis is emeritus professor at The University of Melbourne.

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