Investors should hope BHP pioneer

Last week BHP honoured its promise to shareholders to distribute the $US10 billion proceeds of the sale of its US shale oil assets to shareholders. Anticipating major changes to the imputation credit system next financial year, the company is using its franking credit reserves to pay a special dividend and undertake a large off-market share buy-back where the bulk of the payment is a large fully franked dividend.

Shareholders can only hope other companies follow BHP’s lead and maximise franked dividend payouts this financial year. This would help cushion the blow to low-income shareholders and pension fund investors from losing their cash refunds of franking credits if the government changes.

The imputation credit system encourages companies to use their franking credits as quickly as possible for two reasons. First, resident shareholders can benefit from the full refund of company tax paid only when dividends are paid out. Even when shareholders on higher marginal tax rates face additional personal tax bills on their dividends, the additional tax payable is still lower than that payable on all other income received.

For lower income taxpayers including pension and super funds, the benefits of receiving franked dividends are more substantial. The larger the dividends received and the sooner they are paid, the larger the reductions in tax bills or amounts received as cash refunds are.

Second, the longer companies delay using franking credit reserves, the lower the benefit to shareholders. The franking credit reserves generate no return to the company and are not indexed for inflation. Also, if the company tax rate is reduced, imputation credits generated at higher tax rates can be distributed only at the new lower company tax rate.

Abolishing cash refunds of franking credits would add further disadvantage to a delay in using franking credit reserves. Investors with no or only a small tax liability would be taxed on all income earned in corporate structures. This will reduce the attractions of owning Australian shares for the people directly affected and discourage self provision for retirement.

Many retirees are attracted to owning fully franked dividend paying shares because of the higher yields, including the value of the franking credits. Unless interest rates rise substantially, the benefits of self-provision for retirement will lessen.

If Australian companies want to retain the support of these investors, they will need to focus on ways of cushioning the blow of possible major changes to the imputation credit system.

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Daryl Dixon

Executive Chairman

Daryl Dixon is one of Australia’s foremost investment experts and a well known writer and consultant. He has provided trusted advice to thousands of personal clients over more than 25 years and is an acknowledged expert in the areas of tax, superannuation (including public sector superannuation), social security and investments.

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