Why changes could be afoot for ASX dividend shares and franking credits

A proposed law could effectively kill off the payment of special dividends.

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Key points

  • The federal government is looking to ban companies from paying franking credits under certain circumstances 
  • The move could reduce the appeal of special dividends and other forms of capital management 
  • Shareholders could be on the hook to repay franking credits they received since 2016 as the new law will be retrospectively applied 

ASX dividend share investors might be in for a rude shock as the federal government is looking to claw back some of the past franking credits from investors through their ASX dividend shareholdings.

The proposed law will prevent ASX companies from paying franking credits if the dividends are funded by capital raisings.

Franking credit curse taints some ASX dividend shares

What's more alarming is that the new rule will be applied retrospectively. This means investors and superfunds may have to repay the franking from 2016 onwards.

The new rule, which is open for consultation, could effectively kill off the payment of special dividends.

Which ASX dividend-paying companies are affected

A company is deemed to be funding dividends from a capital raising if the distribution is not consistent with its established practice of making such payouts on a regular basis.

The entity will also have to have undertaken a capital raising before (that means almost every ASX share) and that it's clear that the raise would fund all or part of the distribution or if the company raised capital for the purpose of funding all or part of the distribution.

The government claims the move is to close a loophole that allows companies to release excess franking credits that exceed the profits they make in a given period.

Closing a franking credit loophole but opening a tax hole

Companies like Harvey Norman Holdings Limited (ASX: HVN) have used the so-called loophole in the past to release excess franking credits to shareholders. The retailer paid a fully-franked special dividend and launched a capital raise to fund the payment.

The move is bound to create angst among shareholders. It could leave them on the hook to repay thousands in franking credits that they have received over the past five years.

What's surprising is that the federal Labor government won't be saving much through this controversial change. It's estimated that the franking clawback will save treasury around $10 million a year.

It seems like a risky gamble for the Albanese government for not much return. Who can forget the last time federal Labor tried to mess with franking credits? That, along with other proposed radical changes, cost Bill Shorten his shot at the Lodge.

What kind of capital returns are affected?

Regular dividends are unaffected and ASX dividend shares can still pay special dividends but without franking.

This will significantly reduce the incentive to use special dividends as a means of returning surplus cash to shareholders.

It is unclear at this point if off-market share buybacks will also be affected. These sorts of capital management programs have a "capital component" and a "dividend component" to the offer price. Franking credits are usually attached to the dividend component.

It reads to me that off-market buybacks could be impacted as the dividend part of the offer meets the conditions of the new rule.

You can voice your concerns to the government during the consultation period (until 5th Oct). Instructions can be found on this link.

Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Harvey Norman Holdings Ltd. The Motley Fool Australia has positions in and has recommended Harvey Norman Holdings Ltd. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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