The Australian Securities and Investments Commission today rejected the view that off-market share buy-backs, where part of the price is treated as a franked dividend, were a breach of the Corporations Act.
Buy-back price is not a dividend
In ASIC’s view, no part of the amount paid by a company to buy-back a share is a dividend for Corporations Act purposes, even though it might be taxed as a dividend.
The fact that part of the buy-back price is:
- attributable to retained earnings;
- deemed to be a dividend for tax purposes; or
- franked under the dividend imputation system,
does not make it a dividend for company law purposes.
ASIC also believes that the provision in the Act (s254W of the Corporations Act 2001) that says each share in a class has the same dividend rights does not apply to a payment made to buy back a share. A dividend, for the purpose of that provision, is a distribution of profits as a reward to shareholders as the ongoing equity owners. In a buy-back, on the other hand, participating shareholders agree to give up ownership in return for a lump sum payment. The timing, composition and calculation of that payment do not derive from rights in the constitution, but from the buy-back agreement made with the company. The fact that some or all of the funds used might otherwise have been available for paying dividends does not make the payment a dividend. The dividend and buy-back regimes operate quite separately.
‘A payment for the extinguishment of a share under the buy-back regime is not a dividend under the Corporations Act and never has been. Returns of capital that involve a debit to a profit account have never been treated as a dividend for company law purposes either’, said ASIC Deputy Chairman, Jeremy Cooper.
‘Discriminatory’ features of off-market buy-backs
There has been a clear and public enunciation of the negative implications of off-market buy-backs for ‘retail’ shareholders. An off-market buy-back at below prevailing market prices is unattractive to a ‘retail’ shareholder on a normal tax rate. This means that they generally do not participate, but see lower tax-paying shareholders receiving very large distributions of franking credits, as well as a capital loss against which other capital gains can be offset. This is regarded by opponents of such buy-backs as inequitable and discriminatory, particularly when there are other ways that excess share capital can be returned.
On the other hand, the company can benefit from off-market buy-backs because the greater the tax advantages to certain shareholders, the more likely it is that the company can buy back shares at below prevailing market prices. This is not achievable in an on-market buy-back. Also, it must be assumed that the success of recent off-market buy-backs means that many shareholders are not opposed to them.
It must also be remembered that shareholders are generally not treated equally from a taxation perspective. For example, a special dividend (another way of returning excess capital) is taxed at different rates in the hands of shareholders (i.e. from zero for charities and shareholders with tax losses, up to 48.5 per cent for an individual on the top marginal rate). Off-market buy-backs illustrate this inequality, but do not create it.
Directors’ duties
The question whether it is appropriate for a company to return excess share capital by way of an off-market buy-back, as opposed to some other mechanism, is a matter for the careful consideration of the directors.
‘It is the directors who must be satisfied that, even though a buy-back with franking favours shareholders on low tax rates, the transaction is still in the best interests of the company as a whole. If the directors are so satisfied, then we would not normally second guess their decision, but we do want to see clearer disclosure of their reasons for going down the off-market path’, Mr Cooper said.
ASIC would consider intervening in cases where it believed directors were in breach of their duties (e.g. by only having regard to the interests of low-tax paying shareholders) or, for example, where the information given to shareholders about the buy-back was misleading or otherwise defective. ASIC would also consider intervention if it formed the view that a buy-back were conducted for an improper purpose (e.g. to increase the value of executive options or to concentrate voting power in non-participating shareholders).
Complexity
The decision whether or not to accept an off-market buy-back can be a complex one for a ‘retail’ shareholder. It involves an understanding of capital gains (and losses) and dividend imputation, as well as share price/value considerations. Shareholders also typically have to participate in the Dutch auction tender system to ensure that their shares are actually acquired. ‘Retail’ shareholders are often at a disadvantage in this process. Further uncertainty is created by the fact that the ‘market value’ of each share for tax purposes cannot be finally determined until after the close of the buy-back period.
These are all matter for the directors in determining whether it is in the best interests of the company to proceed with an off-market buy-back. In light of those complexities, companies need to strive to structure their buy-backs to work as equitably and simply as possible and to see that their communications with shareholders are clear, concise and effective.
Clearer articulation of reason for choosing off-market buy-back
Given that there is a debate about the fairness of off-market buy-backs, ASIC believes that directors should be prepared to articulate their reasoning for choosing to undertake them. They should address why they have not chosen other ways of returning excess capital, explain the level of franking credits to be expended and provide any other information that shareholders would reasonably expect to have.
ASIC’s facilitation role
ASIC currently facilitates off-market buy-backs by granting the following relief:
- ‘Dutch auction’ tender: Allowing companies to invite shareholders to tender some or all of their shares using a ‘Dutch auction’ system. This enables companies to accept the lowest bids up to the number of shares sought to be bought back, rather than requiring them to make offers at a fixed price. The relief enables companies to treat these buy-backs as ‘equal access’ so long as each shareholder has the same opportunity to participate, even though there is no guarantee that all or even some of an individual shareholder’s shares will be bought back.
- Scale-back: Allowing companies to scale back the number of shares to be acquired where there are more shares tendered at the buy-back price than were sought to be bought back.
- Priority allocation/Priority tender: Allowing ‘priority allocation’ and ‘priority tender’ arrangements designed to reduce the chances of small holders being left with unmarketable parcels of shares and protecting them from excessive scale back.
‘We could always stop giving this relief which would force companies to make fixed price offers or get shareholder approval under the ‘selective’ buy-back rules. However, if directors follow our guidance and focus more closely on why they are using an off-market buy-back and explain that to shareholders, we should not have to take that heavy-handed step’, Mr Cooper said.