Beware the fully-franked cash cow

“if anybody in this country doesn’t minimise their tax, they want their heads read”: Have Kerry Packer’s words been taken too literally?I wish I paid more tax. I really do. No, I don’t need my head read, and no, I’m not advocating communism. I just wish my tax bill was higher – for the right reasons. Not everyone takes this approach, and I think it’s a shame.
杭州楼凤

But first, back to the early 1990s…

Kerry Packer was larger than life. He was brash, successful and engendered immense loyalty from many of his employees, some of whom became fast friends.

He was also wonderfully quotable.

When appearing before a House of Representatives select committee enquiry in 1991, he was asked to state his name, and the capacity in which he appeared. He answered truthfully:

“Kerry Francis Bullmore Packer. I appear here this afternoon reluctantly.”

Giving – and taking – no quarter

The appearance was fiery, with Packer giving the committee, and by extension the then-government a free character assessment, as well as his views on media laws and foreign investment, among other things. Some of the parliamentarians seemed perturbed, others bemused and a few struggled to keep smiles off their faces at times. Packer was nothing if not a showman.

Perhaps the quote that is best remembered from that appearance was on the subject of tax. He said:

“Of course I am minimising my tax, and if anybody in this country doesn’t minimise their tax, they want their heads read… because as a government I can tell you you’re not spending it that well that we should be donating extra.”

It’s hard to imagine his view would have changed, 23 years later, regardless of which party was in power. He isn’t alone in that view – and for good reason. I don’t know of anyone who pays more tax than they’re obliged to.

Ignore the words, heed the message

The problem for investors is that they’ve taken Kerry Packer’s words too literally. No, I’m not suggesting you should pay more tax than you’re obliged to – if the government needs more revenue they can change the tax scales and other measures accordingly – but experience suggests that Australians pursue tax savings as a goal in itself, potentially to their financial detriment.

You only have to look at the failed timber company Timbercorp, whose main source of business was investors looking primarily for tax benefits. Similarly, Australians spend a lot of money buying new cars to take advantage of salary packaging and/or enter into certain financing arrangements that confer tax benefits. Even some accountants have fallen for the lustre of the tax deductions (either mistakenly, or simply because they know that’s what their clients are after).

Wasting dollars to save cents

Yes, if you’re going to buy a new car, it makes sense to do it tax effectively. But Australians would be far, far better off buying a cheaper used car and eschewing the tax ‘benefits’. I use quotation marks, because there are few circumstances in which you’d pay an extra $20,000 for a car and sign up for finance on top of that to save a few thousand dollars in tax. It’s the equivalent of putting a high ‘sticker price’ on a car so you can then discount it and make the purchaser feel like they’ve negotiated a great deal – or perhaps the all-too-common excuse of buying more of something that was on special, but that you didn’t really need. You know the refrain: “…but look how much I saved!”.

Put the horse back before the cart

The investment equivalent of this is the Australian investors’ obsession with fully-franked dividends. At The Motley Fool, we get plenty of emails from prospective members who ask “do you recommend companies with fully-franked dividends?” Don’t get me wrong, the dividend imputation scheme is one of the great improvements to our taxation and investment climate in recent decades. The end to double-taxation of dividends is a wonderful thing – and a benefit still enjoyed only by investors in a few countries.

But dividend imputation – franking – can’t be an end in itself. Thoughtlessly applied, it’s the equivalent of paying twice as much for your automobile of choice, just to save a few quid on tax.

The main objective – indeed the only rational objective – of investors is simple: to maximise the after-tax return from your investment portfolio. Yet too few investors consider their investment approach from this lens. Here’s a simple example: many investors eschew a 5.8% unfranked dividend, but would happily embrace a 4% fully-franked one – “just think of the tax benefit”. As you can probably guess, given the theme of this article, that’d be a false economy. If, as an investor, you only want fully-franked dividends, you’re reducing the available pool of potentially attractive investment opportunities – to your detriment.

Foolish takeaway

I started this article with a view that I wanted to pay more tax. It’s true. I hope to have a successful professional career and similarly successful investment returns. The better I do, the more money I earn – and the more tax I’ll pay. Yes, I’ll take advantage of legal deductions to the extent possible, but I won’t be doing anything with the sole aim of minimising my tax.

Instead, my only goal will be to maximise my after-tax return. Remember that next time your accountant, financial planner, friend or cabbie – or some slick advertising – suggests buying a new car, investing in plantation timber or investing in the next great Australian film. Your first hint will be the focus on the tax implication, and little mention of your overall return.

Attention: Foolish, dividend loving investors and BusinessDay readers alike who are looking for Australian investing ideas can click here to request a Motley Fool free report entitled Secure Your Future with 3 Rock-Solid Dividend Stocks.

Scott Phillips is a Motley Fool investment advisor. You can follow Scott on Twitter @TMFGilla. The Motley Fool’s purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).

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