ANZ payment of tax to fund fully franked dividends raises eyebrows

ANZ Banking Group has paid an instalment on its 2016 financial year company tax in order to get enough credits to maintain a fully franked final dividend in 2015, raising the spectre of future ANZ dividends being only partially franked or the dividend payout ratio falling to reflect the growing proportion of earnings ANZ makes offshore.

Companies receive franking credits for company tax paid in Australia, which are paid to shareholders in the form of franked dividends, on which tax does not have to be paid again. But franking credits are only received on Australian income; according to its full-year accounts, ANZ earns 61 per cent of its income in Australia, and 39 per cent offshore.

Despite this, ANZ has a target dividend payout range of 65 per cent to 70 per cent of profits, and has been paying this out as fully franked dividends, which are highly desired by shareholders.
In a statement to the Australian stock exchange on Friday, ANZ said it “confirmed that it expected to fully frank dividends for the foreseeable future”. “We have consistently stated that we expect to fully frank dividends for the foreseeable future. That position has not changed,” chief financial officer Shayne Elliott said.

ANZ’s annual report, released on Monday, suggests the bank is running low on franking capacity: the final, proposed dividend for 2015 of 95¢, which will be paid on December 16, utilised the entire balance of $593 million of franking credits available at September 30, ANZ said.

In order to pay a fully franked final dividend in 2015, ANZ has used franking credits generated by paying some of its 2016 tax bill

The annual report said “instalment tax payments on account of the 2016 financial year which will be made after 30 September 2015 will generate sufficient franking credits to enable the final 2015 dividend to be fully franked”. ANZ also used some 2015 tax instalments to sustain the full franking of its 2014 dividend.

Analysts suggest this is not sustainable and may force ANZ to partially frank its dividend – like Macquarie Group does – or reduce the payout ratio.

Shareholders won’t like either way

Watermark Funds Management analyst Omkar Joshi said the component of Australian earnings ANZ is paying tax on is declining as a percentage of group earnings, while at the same time, the dividend payout ratio has been increasing.

“This has to fix itself up somehow. One obvious way is for ANZ to reduce the payout ratio, which has to fall below the level of earnings the bank makes in Australia income to keep it fully-franked. The other alternative is to do a partially franked dividend.

“Either way, retail shareholders are not going to like it. But those are the only ways you can solve the issue.”

ANZ warned in its annual report that: “The extent to which future dividends will be franked will depend on a number of factors, including the level of profits that will be subject to tax in Australia.”

A spokesperson for the bank said on Thursday that ANZ expected to pay instalments on its 2017 tax to sustain fully franked dividends in 2016, but could not comment on the dividend policy beyond that.

ANZ said in its full-year accounts, released on October 29, it would pay $2.758 billion out in dividends in the second half of 2015, which would have required $1.182 billion in the franking account. With the balance of $593 million being exhausted, Mr Joshi said it appears $589 million has been found from paying the tax.

But this means ANZ will only have $400 million left in franking credits for the first half of 2016, based on its generation of $1 billion in franking credits each half. This will require another payment of taxation to sustain the full franking.

This path ‘not sustainable’

“It is not sustainable to go down this path indefinitely,” Mr Joshi said. “At some point, either your Asian earnings have to decline as a percentage of the group, the dividend payout ratio has to fall or the franked component of the dividend has to decline.”

Outgoing chief executive Mike Smith said on October 29 that the bank remains comfortable with its range of 65 to 70 per cent of profits being returned to shareholders each year and it would it take a “massive problem” with bad debts for this to be reduced.

However, other financial services firms – who pay significant amounts of tax abroad – that don’t receive the benefits franking have reduced payout ratios, or franking levels or both.

For example, Macquarie’s consensus forecast is for a payout ratio of 65 per cent, but it only pays a 40 per cent franked dividend, and there was zero franking in 2011 and 2012. QBE has a fully franked dividend, but is expected to only pay out 52 per cent of profits as dividends next year.

The issue of ANZ exhausting its franking credit balance has been raised before. At the half-year results in 2013, CFO Shayne Elliott, who will replace Mr Smith as CEO on January 1, said the issue was a problem ANZ “looked forward to having”, given it reflected offshore profit growth.

But at same briefing, Mr Smith hinted a dual listing for ANZ might be considered if it ran out of franking credits, or it might negotiate with the Australian Taxation Office to preserve the benefits of franking for Australian shareholders.

A dual listing would allow Australian shareholders, who value franked dividends highly, to invest in ANZ on the Australian bourse and receive franking credits for local tax paid, while foreign investors could buy its shares on another exchange and would not be offered franking credits.

Correction: An earlier version of this story said ANZ had “pre-paid” its tax. The tax payments were regular monthly tax payments paid in the normal course of business.