Turning a loss into a gain
When an issuing company buys back some, or all, of its shares, the price offered is generally lower than the current market price. This causes many SMSF trustees to disregard the offer because to sell at a price below market value doesn’t seem to make sense.
In many cases, however, it makes very good sense. A share sold back to the issuing company comprises a dividend and a return of capital. Selling the shares below the purchase price results in a loss to the capital component. This can benefit an SMSF while in the accumulation phase because the loss does not attract Capital Gains Tax (CGT). (No CGT applies while in the pension phase).
Some trustees actively invest in companies that are offering to buy back shares because the dividend component is generally franked, meaning the tax has already been paid by the fund at the company tax rate of 30 per cent.
The maximum tax rate for SMSFs is 15 per cent on dividend income when in the accumulation phase (and zero per cent when in the pension phase), so the excess tax paid can be used as credits to offset the fund’s other tax liabilities.
The following table illustrates how selling shares back to the issuer at a loss can result in a real return to an SMSF.
Per share A$ |
Accumulation |
Pension |
Purchase price before buy-back |
$28.00 |
$28.00 |
Buy-back offer price |
$25.62 |
$25.62 |
Capital component of offer price |
$3.08 |
$3.08 |
Fully franked dividend |
$22.54 |
$22.54 |
Franking credit |
$9.66 |
$9.66 |
Excess franking credit |
$4.83 |
$9.66 |
Capital loss benefit |
$3.30 |
$0.00 |
Net after-tax proceeds |
$33.75 |
$35.28 |
Purchase price less after-tax proceeds |
$5.75 |
$7.28 |
Net return on buy-back shares |
20.5% |
26% |
Calculations based on the Woolworths share buy-back in August 2010 |
In this example, the net after-tax proceeds comprise the fully franked dividend, the capital component of the offer price, the excess franking credit and the capital loss benefit. After deducting the pre-buy-back purchase price, the result is a positive net return on the participating shares.
If the calculation was to be extrapolated out to 1,000 shares, the result can make a significant difference to an SMSF’s tax and income positions.
With this in mind, buy-back schemes are becoming increasingly popular, which means issuing companies often limit the number of shares they are willing to repurchase. It’s imperative that SMSF trustees take this into account prior to embarking on a buy-back strategy.
It’s equally important to consider your SMSF’s future investment plans when determining if a buy-back scheme is appropriate. If you would like further information please phone us on 02 9318 6400 or email fred.tortora@surrypartners.com.au.