Companies hoarding $45bn in franking credits

The Australian

James Kirby, Wealth Editor

15 December 2018

A staggering $45 billion worth of franking credits are being hoarded by some of
Australia’s biggest companies and demands to release them before an ALP
government comes to power are rising fast.

New research on some of our biggest stocks reveals companies such as Rio, Fortescue
and Caltex have a treasure trove of stored up franking credits. In an extreme example,
Harvey Norman’s franking credits are equal to 14 per cent of the retailer’s $3.7bn
market value.

But these credits will be useless to a significant shareholder segment if the ALP wins
the next election, as the opposition plans to scrap the cash rebates retiree investors
receive on franking credits despite franked shares making up the backbone of most
small shareholder portfolios.

“If franking credit was a listed company, it would rank as the seventh biggest company
in Australia,” says Hasan Tevfik, a senior analyst at MST Marquee who has run the
numbers on the ASX. Tevfik’s research shows major companies are hanging onto
franking credits when there appears to be very little reason to do so.

JB Hi-Fi, Woodside, Woolworths and Flight Centre — all favourites with retail
shareholders — also appear high on the list that has been compiled excluding financial
stocks since banks generally distribute all their franking credits on a regular basis.

BHP and Rio have already made some effort to release their excess franking credits but the report shows that, even including their planned measures, they still have franking credits that are relatively high — representing about 7.4 per cent of the market capitalisation at BHP and 10.3 per cent at Rio.

In an ideal world, listed companies would have little or no franking credits stacked up
on the balance sheet but, citing conservatism, many blue-chip groups use them as a
buffer to be used in tough times.

The problem now is such conservatism could carry a high cost that will be shouldered
by older investors if the ALP goes ahead with its controversial plans. Opposition
Treasury spokesman Chris Bowen has repeatedly said he will not budge on the issue.

Typically, companies can get the franking credit value off their books and into small
shareholders’ pockets through special dividends or buy-back programs.

The new research follows a similar exercise a year ago by Macquarie Bank. That
report, based on results in the year to June 2017, showed the worst companies in terms
of franking credits had been Salmat, The Reject Shop, New Hope Corporation,
Cabcharge and BHP.

Macquarie Bank has been collecting franking credit data for more than a decade as
investors have always kept an eye on credit balances to ensure capital management
was optimised.

Analysts argue that companies with franking credits banked up on their books may not
be acting in the best interest of shareholders if they resist actively distributing those

“We know some of these companies have resisted and boards have waved off
questioning shareholders … but we find the excuses poor,” says Tevfik. “The ALP policy will make franking credits worth less to the aggregate shareholder.”

Under existing arrangements, the vast majority of retirees are tax free. When
Australian companies pay dividends they have franking credits attached — the system
was originally introduced by the Labor government. Shareholders who have tax bills
can offset their franking credits from their annual tax.

However, retiree shareholders — who are tax free — don’t have a tax bill to offset. To solve this issue, the Howard government introduced a rebate plan where retirees could
get a cash cheque in lieu of their shareholder rights in relation to franking.

The ALP opposition has proposed scrapping this arrangement with no compensation
— retirees who are on pensions or part-pensions are exempt.

It is estimated the average retiree investor gets about $6000 a year in franking credits.
In recent weeks the issue has become a key area of political debate as fund managers
led by Wilson Asset Management’s Geoff Wilson protest against the scheme.

Opponents suggest the plan is discriminatory as it isolates a specific section of the
community — older independent investors — on a tax measure.

Wilson, who raised a petition against the change, believes the ALP measure is
essentially unfair and penalises investors who have constructed their portfolios on
what many had taken to be a settled government policy.

Earlier this year he suggested: “What disturbs me is that I don’t think people
understand how crippling these changes will be to people who have abided by all the
laws for the last 20 years.”

The debate has been inflamed by union-backed industry super funds suggesting they
would not be affected by the measure.

This is because franking credits are not being terminated — rather, it is the right of
independent retirees to receive cash for those credits that is being terminated. As a
result, most large-scale funds — industry or retail — will not be affected since they
can still use the franking credit offsets.

With $45bn worth of credits yet to be distributed, time is running out for the biggest

James Kirby, Wealth Editor