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Franking Credits in Fixed Income Investing (90 day holding period rule)

For investors of Australian shares, dividends paid to them by Australian resident companies are taxed under a system known as ‘imputation’. It is called an imputation system because the tax paid by a company may be imputed or attributed to the shareholders. The tax paid by the company is allocated to shareholders by way of franking credits attached to the dividends they receive. The franked dividends effectively prevent double taxation and allow investors to be taxed only once, at their personal tax rate, as long as the investment in shares satisfies the ATO’s ‘Holding Period Rule’, that is, investors must continuously hold shares ‘at risk’ for at least 45 days to be eligible for the franking credit offset.

For investors in some Australian Bank Hybrid Securities, interest payments may be subject to the same imputation system, and up to 30% of the interest payments maybe passed on to investors in the form of franking credits similar to dividends on shares. A key difference here is that, under the ATO’s ‘Holding Period Rule’, investors in Bank Hybrid Securities must continuously hold the instrument ‘at risk’ for at least 90 days to be eligible for the franking credit offset. Click here for more information from the ATO.

The ATO holding period rule is aimed at investors looking to ‘wash’ dividends and double claim franking credits rather than those investors holding these securities for the medium term or until maturity.

The key point to highlight to investors is that they should not be buying Bank Hybrid securities within the final 90-Day period prior to redemption assuming a grossed-up yield. As the investor will not be eligible for franking credit offset the investor should only consider buying them on cash or net yield (i.e excluding franking credits).

As an example, ANZ Convertible Preference Shares 3 (ASX Code: ANZPC), which is expected to redeem on 1st Sept 2017 had a closing Yield to Expected Maturity of 4.89% on 11 July 2017. However, because we are now within the “at risk” period for hybrid securities prior to redemption (assuming the do redeem) the cash (or net) yield for new investors is 3.42%. So while this is a small tax factor in the hybrid market there is an important distinction in pricing for existing investors rather than new investors.

Disclaimer

This information is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser. Taxation, legal and other matters referred to are of a general nature only and are based on BondAdviser’s interpretation at the time and should not be relied upon in place of appropriate professional advice. Those laws may change from time to time.

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