11 October 2024
Managed accounts? Simple.
For advisers and their clients, are managed accounts simply a better way to invest? Read more to find out why managed accounts have become so popular with investors and advisers. Read more
Last week, Rio Tinto (RIO) announced to the ASX that they will be conducting an A$500 million off market buy-back of their shares. This announcement has again brought into focus just how beneficial direct assets and after tax management can be for investors.
Under this buy-back, shareholders can sell their shares back to RIO at a discount. You might wonder; why would anyone do this? The answer is in the tax treatment. Buy-backs like this one can offer significant taxation benefits.
By owning a portfolio directly, investors with low tax rates can use buy-backs such as this to create significant value. Let’s take a close look at how the RIO offer operates, to best understand the benefits.
RIO shareholders will be able to tender their shares at a discount (of 8% to 14%) to the average trading price for the 5 trading days up to, and including, April 2. The final tender price will then be paid as $9.44 capital and the balance as a fully franked dividend. For those on low tax rates, this will provide an excess of franking credits, plus a capital loss to offset against other gains.
To demonstrate the benefit, we have included an example below. We have assumed that the investor acquired the shares at $63.79 (closing price on Fri 13th Feb 2015) and are bought back by RIO at a 14% discount to this, being $54.86. In this situation, the investor would receive;
| Country | 5 year bond yield |
|---|---|
| Australia | 1.61% |
| United States | 1.10% |
| Great Britain | 0.40% |
| Germany | 0.57% |
If the investor is a super fund then they will either pay tax of 15% if in accumulation phase, or 0% if in pension phase. So the tax on the income would be;
| Period Return (US$) | Return (A$) |
|---|---|
| 27/10/08 - 27/07/11 | 63.4% -9.2% |
| 27/07/11 - 19/07/16 | 84.7% 171.2% |
Additionally, Super Funds in Accumulation phase would record a capital loss. This loss can be used to offset other gains in the current, or future, years. The value of this loss can be calculated as follows;
[table “3” not found /]Notes;
* The ATO has a formula for calculating the assumed sale price. This is calculated as the capital component ($9.44) plus the difference between the ATO’s deemed value (this is hard to predict, but we have assumed it to be $60.23) and the buy-back price.
** The tax saving assumes that the losses offset gains on assets held longer than 12 months. In a super fund, only two-thirds of these gains are taxable, so only two-thirds of the loss will offset tax.
In all, should a Super Fund buy today and then tender their shares into the buy-back, the benefit to the investor for each share is;
[table “4” not found /]As you can see, for low rate tax payers (super funds and low marginal rate individuals), buy-backs such as this can often be a good way to generate additional after tax returns. However to be able to take advantage of this investors need;
- To be direct investors – these opportunities are not available to people who own shares via managed funds or Exchange Traded Funds. Investors need to directly purchase the security on the ASX.
- To be the legal owner, with their own HIN – Many wraps, master trusts and other platforms use a Custodian to hold the shares on behalf of the investor. This could mean that there is one HIN (Holder Identification Number), under which thousands of investors’ shares are held. In this circumstance, it is often not possible to take advantage of corporate actions, such as buy-backs, due to the rules of those actions.
- To manage their money on an after tax basis – A fund manager who thinks only about pre-tax returns, would not buy something at $64 so they can sell at $54. But as we now know, there can be good after tax returns for the right investors. Investors should therefore ensure that whoever is managing their money is doing so based on the best after tax outcome.
Elston is a firm believer in controlling outcomes for its clients. This allows us to boost net returns for investors without adding extra risk. Under our premium IMA service, we invest directly wherever possible. All investors retain legal title to their assets and we make decisions based on the best after tax outcomes.
Investors who are not doing these things, are possibly achieving sub-optimal outcomes.
It should be noted that any investment carries risk. These buy-backs do not suit every investor and these offers usually suffer from large scale backs. It is highly recommended that any investor considering participating should seek professional investment advice.
