How do “Off-Market” Share Buy-Backs work?

Matt Richardson

Recently Commonwealth Bank (CBA) and Woolworths (WOW) had offered investors the chance to take part in an “Off Market” buy back of shares.

In general terms this requires an investor to “tender” their shares for sale through the buyback offering.

The final buy back price is typically at a discount of around 14% of a “weighted average market price” over a stated period (e.g., two weeks).  The buyback proceeds are split into two components.

Component 1 – a capital component, usually a value significantly lower than the current market price.

Component 2 – a fully franked dividend component.

So why would an investor consider selling shares through a buyback offering, at a 14% discount to the price the shares could be sold for on the ASX?

The answer depends entirely on the tax position of the investor!

Example – Commonwealth Bank Buy Back

The final buy back price of the recent CBA buy back was $88.62 as this represents a 14% discount to the weighted average price.  This is broken up into 2 components:

  • Capital Component                         $21.66
  • Fully Franked Dividend                  $66.96

The dividend will have franking credits of $28.58 per share attached to the dividend, however, the franking credits are not “received” until the investor completes and lodges their annual tax return.

In the event the investor is a Self-Managed Superannuation Fund (SMSF), with 100% of the SMSF assets being used to pay pensions, the tax rate on the dividend is 0%.  These means 100% of the franking credits will be refundable, resulting in a total return of $117.20 (buy back proceeds of $88.62 plus franking credits of $28.58).

However, if you are an individual investor with a marginal tax rate of 34.5% (taxable income between $45,000 and $120,000), the buyback is not as attractive.  The fully franked dividend component, plus the franking credit, is included in your taxable income.

This will result in a $4.38 tax penalty on the buyback proceeds of $88.62, leaving you with net proceeds of only $84.24.  In this case the after-tax proceeds are well below the current market value on the ASX.  The tax penalty is calculated as follows:

Fully Franked Dividend $66.96  

plus Franking Credit                $28.58

equals Taxable Income               $95.54                

Tax on Taxable Income @ 34.5% $32.96

Less Franking Credit $28.58

Tax To Pay $4.38

In summary, if the investor’s tax rate is 0%, buy backs will generally be attractive to be a part of.

This illustration is merely showing the after-tax and cash flow consequences of a buyback transaction and should not be considered financial advice.