A bumper earnings season has seen many major portfolio stalwarts such as Telstra, Woolworths and the major banks announce share buyback schemes.
Some of these are on-market, meaning there is no decision making required by shareholders. Others are off-market (such as Woolworths and CBA) which involve the holder making a decision about their participation. Often reams of confusing paperwork are sent to shareholders offering an opportunity to be involved.
A share buyback is a good use of excess cash for a company. It allows them to reduce their shareholder base while distributing the cash in a tax effective way to the shareholders. Typically, the shares are bought back at a discount (usually 10-14%) from the prevailing share price. It raises the obvious question – why would you accept this if you could sell these shares at a discount when you could sell them on-market at the current market price?
The answer is typically for tax reasons. The proceeds you are paid in a buyback are often made up of different components than if you just sold the shares. The proceeds can be part-fully-franked dividend, part-capital. If the part-capital is quite small, it may significantly reduce any capital gain implications. Perhaps even enough to offset the buyback discount making it a more profitable transaction.
For example, the current Woolworths Buyback price is made up of two components. The first, $4.31 per share, is the capital component. This is the price compared to your purchase price for calculations of capital gains tax. Given the share price for Woolworths is currently over $40, which for many is a significant gain on the price they paid for the shares, this potentially turns a large capital gain into a capital loss, thus reducing or eliminating Capital Gains Tax.
The difference between the buyback price (remember it will be at a 10-14% discount to the current price) and the capital return ($4.31 per share) will be a dividend, possibly fully franked. A one-off larger dividend due to buyback participation also needs to be considered in your tax planning.
Should I participate in the buybacks?
Our general rule with buybacks is that if you don’t need the cash and you remain a long term investor, we typically don’t participate. Again though, every circumstance is different and a simple answer often can’t be given. Contact us today, we are always happy to discuss what is a complex subject with you.