Generating income from Australian share buybacks
Participating in off-market Australian share buybacks, is one way Plato generates additional after-tax income for retirees and other zero-tax investors.
Off-market share buybacks are a way for companies to divert the franking credits on their balance sheets to the investors that value them most – zero-tax investors.
To provide an illustration of how low-tax investors can benefit from off-market share buybacks, let’s look at the Commonwealth Bank (ASX: CBA) off-market buyback that was completed in August 2021.
Commonwealth Bank was trading at $103 per share at the time and they were able to purchase back their shares in the off-market buyback at $88.62.
You might ask, why would anyone allow their shares to be bought back at $88.62 when it is trading at $103?
The reason is because of the way the buyback is structured. It has a capital component and then it has a fully franked divided component on top, and that fully franked dividend carries franking credits. So, in Commonwealth Bank’s case it had a $21 capital component and then the remainder was a fully franked dividend which then had franking credits on top.
When you added that all together you actually found that the value for a zero-tax investor was just over $117 (because they get to reclaim those franking credits back from the government). This was 14% more than the current share price of Commonwealth Bank at the time.
So you can see why off-market share buybacks can be very profitable for zero-tax investors.
For tax paying investors, particularly high marginal tax rate investors, these buybacks aren’t actually profitable because they pay income tax on the full value of the fully franked dividend and the franking credits attached.
The Plato Australian Shares Income Fund, is designed specifically for zero-tax investors, so we actually make all our decisions on the basis of how a zero tax investor benefits, thus we regularly participate in these buybacks.
Since the inception of the Fund in 2011, we have gained about 40 basis points per annum just by participating in buybacks and added that to the total return of our investors.
We think it is a great way for investors to get the icing on the cake in terms of their income.
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Plato Investment Management is an Australian owned boutique equities fund manager specialising in maximising retirement income for pension phase investors and SMSFs. To find out more visit our website.
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Peter is a Senior Portfolio Manager and manages the Plato Australian Shares Income Fund. He is a founder of Plato and has 15 years investment experience. Peter received 1st Class Honours and a PhD from UNSW.