BHP's gigantic $5 BILLION off-market buy-back will be conducted as a tender. Essentially shareholders compete to be involved by bidding at a discount to the market price.
They are prepared to sell their shares for less than the market price because when they are paid for their shares they are deemed to have received a combination of a (small) capital amount and a franked dividend. Thus they not only get franked income but a significant capital loss to set against profits elsewhere.
That makes the buy-backs particularly attractive to shareholders with zero or low tax rates, like superannuation funds or charities, and quite unattractive to shareholders on the top marginal tax rate.
Some critics refer to off-market buy-backs as taxpayer-funded rorts. They are not that. Companies accumulate franking credits because they have paid tax. The objective of the dividend imputation system was to remove the previous double-taxation of profits at the corporate and individual levels.
In fact the existence of the franking credits says that Australian company taxes have been paid and all the buy-back does is bring forward the ability to use excess credits and deploy them more efficiently and to the benefit of the entire shareholder base that, given they are an asset of the company, owns them.
With my superfund being in pension phase and thus exempt from income tax, the BHP buy-back is highly attractive since all - bar a small capital amount of 28 cents - is deemed to be a fully franked dividend.
This franking credit, being 30/70th of the buy-back price (less 28 cents), is a 42.85% "bonus", which is well in excess of the discount of 10% to 14% at which BHP proposes to buy back the shares. Indeed, it translates into an immediate share price gain of at least 28.85% or, at most, 32.85%.
For more information, read the Buy-Back Booklet and to do your own sums, use this Tax Calculator.
I intend to tender all the fund's BHP shares into the buy-back; however, I expect it to be heavily oversubscribed and my own tender scaled back proportionately. But don't take my word for it, listen to Paul Rickard.
Dividend Imputation System and Franking Credits Explained
