Labor’s tinkering with franking credits could rain on future capital raisings

Attempts to generate an estimated $59bn in government savings over 10 years, by taking a blowtorch to the refunds you’ve previously come to expect in franking credits, did little to ingratiate Labor to the electorate back in 2019.

While this is one of many reasons why Labor lost what many regarded as an unlosable election, the Albanese-led government again has plans to tinker with the holy grail with Australian tax law that many regard as sacrosanct.

But unlike 2019, Treasurer Jim Chalmers has advised investors that the previous policy remains dead in the water.

Companies not retirees

Meanwhile, this time around, proposed changes to franking credits, are aimed at companies rather than retail investors, notably self-funded retirees that previous Labor policy clearly had on its radar.

Chalmers regards proposed changes to franking credits are mere technicalities that would simply tidy up the mess that the previous government never had time to incorporate within a budget document.

Be that as it may, attempts by Labor to tie up to loose ends around franking credits - which appears to be embedded in the idea of using capital raisings to fund franked dividends – heralds unintended consequences.

What’s being proposed?

According to the draft legislation, proposed rules, that apply to all distributions paid after December 2016, aim to prevent companies from “unlocking” franking credits by using capital raisings to fund share dividends.

By introducing these changes, Labor plans to stop companies from what it regards as manipulation of the system to obtain what it also regards as inappropriate access to franking credits.

Labor argues that capital raisings are an “artificial arrangement” to fund the payment of franked distributions to shareholders.

However, what’s missing is a clear distinction between what are considered acceptable activities and the loophole it is trying to close.

History lesson

Banks are by no means the only companies in the eye of these changes but the retrospective nature of proposed changes illustrates how Labor is at odds even with the regulator.

As covid gained a foothold in 2020, APRA chair Wayne Byres urged the big-four banks to consider a more cautious position on paying out dividends.

Byres inferred, rightly as it happens, that the chickens may come home to roost for companies using core capital to help pay dividends.

Historians among you may recall that both Westpac (ASX: WBC) and National Australia Bank (ASX: NAB) both paid fully franked dividends after monster capital raisings.

Will companies rethink capital raisings?

Bottom line is the one-size-fits-all nature of the planned changes could force boards to rethink fund raisings.

Even if funds raised by a company are quarantined and used for a specific purpose, the draft rules suggest “this may serve to free other funds to be distributed that would otherwise have been required to be used for that purpose."

While cash from a raising would still be considered as funding the dividend, rules within the proposed draft also apply to underwritten dividend reinvestment plans or an underwritten rights issue.

Harmful to capital markets

Having been a vocal opponent of Labor’s failed plans to tinker with franking credits four years ago, Geoff Wilson, founder of Wilson Asset management is again asking Labor to cool its jets on proposed changes to franking credits having concluded they could be detrimental to capital markets.

Then there’s rival fund manager, Angus Gluskie, chairman of the Listed Investment Companies & Trusts Association, who has reached similar conclusions to Wilson that Labor's meddling could be potentially troublesome.

In short, Gluskie argues that proposed legislation as drafted could unintentionally catch many ­thousands of situations of legitimate company operation.

The net effect, Gluskie continues could “delay or significantly discourage the normal processes of capital raising, investment and economic growth within ­Australia."