# Analysing the Telstra buy-back: Part 2

## Key Points

• Attractive to companies if discount less than the maximum
• Can work for individuals with the right facts and circumstances
• Keep an eye on 5 day VWAP calculation

In marginal tax rate (for instance, those who earn the bulk of their income from a tax exempt super pension).

In the lowest income tax bracket (0% tax rate), the analysis is similar to that of a pension mode super fund (see Table 2 in Part 1). The fact that the (refundable) franking credit is larger than the buy-back discount means the off-market buy-back is more attractive than selling on-market.

But remember that when it comes to individuals, it’s the marginal rate that matters. You may have no other taxable income, but if you sell one hundred thousand Telstra shares into the buy-back, the franked dividend component (which is taxable) will push you into the top income tax bracket, no matter what your cost base in the shares is.

Let’s turn now to the second lowest tax bracket – 19.5 per cent plus Medicare Levy – which applies to those with income up to \$37,000. Shareholders that fall into this bracket can also benefit under certain circumstances. Table 3 shows the 'standard' analysis for someone in this tax bracket.

Taxpayer's cost base in shares
Table 3: Individual in 19% tax bracket (plus Medicare Levy) (12% Discount)
Low (\$3) Med (\$4) High (\$6)
Income tax calculations
Less: capital component  2.33  2.33  2.33
Franked dividend component  2.69  2.69  2.69
Add: franking credit  1.15  1.15  1.15
Assessable (taxable) income  3.84  3.84  3.84
Gross tax payable (assess income x tax rate) -0.81 -0.81 -0.81
Add: franking credit offset/refund  1.15  1.15  1.15
Net tax refundable/(payable)  0.34  0.34  0.34
Capital Gains Tax calculations
Capital Component  2.33  2.33  2.33
Total Capital Proceeds  3.01  3.01  3.01
Less: Assumed cost base -3.00 -4.00 -6.00
Net capital gain/(loss)  0.01 -0.99 -2.99
Net tax payable on capital gain (capital gain x tax rate) (3)  -    -    -
Total cash proceeds
Add/subtract: Net tax refundable/(payable)  0.34  0.34  0.34
Subtract: Net tax payable on capital gain (2)  -    -    -
Total cash proceeds from buy-back  5.36  5.36  5.36
Value of capital loss (4) -0.00  0.10  0.31
Analysis of sale on-market
Capital Gains Tax calculations
Sales proceeds (5)  5.70  5.70  5.70
Less: Assumed cost base -3.00 -4.00 -6.00
Net capital gain/(loss)  2.70  1.70 -0.30
Net tax payable on capital gain (3) -0.28 -0.18  -
Total cash proceeds
Sales proceeds  5.70  5.70  5.70
Less: Net tax payable on capital gain (3) -0.28 -0.18  -
Total cash proceeds from selling on-market  5.42  5.52  5.70
Value of capital loss (4)  -    -    0.03

Assumptions:
(1) Telstra share price is \$5.70 and buy-back discount is 12%
(2) Individual in 19% marginal tax bracket (plus 2% Medicare Levy)
(3) Capital gains discounted by 50%
(4) Capital loss can be offset against capital gains (at same tax rate)
(5) Brokerage not included

It's critical to note that the figures are calculated on the assumption that any capital losses generated by the buy-back are used to offset discounted capital gains, which are also taxed at the same rate.

But in many cases, the earnings of individuals will vary from year to year. For instance, the receipt of a large capital gain on the sale of an investment property might, on its own, push someone into a higher tax bracket in the following year.

If the capital losses aren’t used in the year they’re generated (which will be the case if no other assets have been sold) then it’s your tax rate in the year you use them that’s relevant. If, for example, in the following year a large capital gain takes you into the 32.5% (plus Medicare Levy) bracket, then any capital losses carried forward are far more valuable.

Using our example (from Table 3), imagine you’re a shareholder with a cost base of \$6 and generate a capital loss of \$2.99 per share. If that’s used to offset capital gains that would otherwise have been taxed at 19% (plus Medicare Levy), it’s worth 31 cents (assuming the 50% capital gains discount applies). But if you move up to the 32.5% bracket, the capital loss almost doubles in value (to 52 cents) and the buy-back leaves you better off overall (\$5.88 in total versus \$5.73 selling on-market).

If you happen to have non-discounted capital gains, or get pushed into an even higher tax bracket, it’s worth more again. A \$2.99 capital loss saves \$1.47 if it’s used to offset non-discounted capital gains at the highest tax rate (including debt levy) meaning a shareholder in this situation makes \$6.82 overall – more than a pension mode super fund.

There’s unlikely to be many people to whom this particular example applies, but you’ll often find your tax rate changing from one year to the next. If you’re trying to place a value on capital losses make sure you value them at the rate at which they’re likely to be used.

In what other cases are off-market buy-backs attractive to individuals? If the Telstra buy-back discount is set at 10% (or lower) it would be more attractive to low tax bracket shareholders than selling on-market, no matter what value they place on the capital losses (see Table 4). Of course, if they can use the capital losses at a higher rate, it’s even better.

Taxpayer's cost base in shares
Table 4: Individual in 19% tax bracket (plus Medicare Levy) (10% Discount)
Low (\$3) Med (\$4) High (\$6)
Income tax calculations
Less: capital component  2.33  2.33  2.33
Franked dividend component  2.80  2.80  2.80
Add: franking credit  1.20  1.20  1.20
Assessable (taxable) income  4.00  4.00  4.00
Gross tax payable (assess income x tax rate) -0.84 -0.84 -0.84
Add: franking credit offset/refund  1.20  1.20  1.20
Net tax refundable/(payable)  0.36  0.36  0.36
Capital Gains Tax calculations
Capital Component  2.33  2.33  2.33
Total Capital Proceeds  2.90  2.90  2.90
Less: Assumed cost base -3.00 -4.00 -6.00
Net capital gain/(loss) -0.10 -1.10 -3.10
Net tax payable on capital gain (capital gain x tax rate) (3)  -    -    -
Total cash proceeds
Add/subtract: Net tax refundable/(payable)  0.36  0.36  0.36
Subtract: Net tax payable on capital gain (2)  -    -    -
Total cash proceeds from buy-back  5.49  5.49  5.49
Value of capital loss (4)  0.01  0.12  0.33
Analysis of sale on-market
Capital Gains Tax calculations
Sales proceeds (5)  5.70  5.70  5.70
Less: Assumed cost base -3.00 -4.00 -6.00
Net capital gain/(loss)  2.70  1.70 -0.30
Net tax payable on capital gain (3) -0.28 -0.18  -
Total cash proceeds
Sales proceeds  5.70  5.70  5.70
Less: Net tax payable on capital gain (3) -0.28 -0.18  -
Total cash proceeds from selling on-market  5.42  5.52  5.70
Value of capital loss (4)  -    -    0.03

Assumptions:
(1) Telstra share price is \$5.70 and buy-back discount is 10%
(2) Individual in 19% marginal tax bracket (plus 2% Medicare Levy)
(3) Capital gains discounted by 50%
(4) Capital loss can be offset against capital gains (at same tax rate)
(5) Brokerage not included

Unfortunately, a 10% discount isn’t enough to make it attractive to those in the 32.5% bracket (see Table 5). Even a higher tax rate in the following year – much less likely when starting from the 32.5% tax bracket – isn’t enough to make the capital loss of high cost shareholders worth participating.

Taxpayer's cost base in shares
Table 5: Individual in 32.5% tax bracket (plus Medicare Levy) (10% Discount)
Low (\$3) Med (\$4) High (\$6)
Income tax calculations
Less: capital component  2.33  2.33  2.33
Franked dividend component  2.80  2.80  2.80
Add: franking credit  1.20  1.20  1.20
Assessable (taxable) income  4.00  4.00  4.00
Gross tax payable (assess income x tax rate) -1.38 -1.38 -1.38
Add: franking credit offset/refund  1.20  1.20  1.20
Net tax refundable/(payable) -0.18 -0.18 -0.18
Capital Gains Tax calculations
Capital Component  2.33  2.33  2.33
Total Capital Proceeds  2.90  2.90  2.90
Less: Assumed cost base -3.00 -4.00 -6.00
Net capital gain/(loss) -0.10 -1.10 -3.10
Net tax payable on capital gain (capital gain x tax rate) (3)  -    -    -
Total cash proceeds
Add/subtract: Net tax refundable/(payable) -0.18 -0.18 -0.18
Subtract: Net tax payable on capital gain (2)  -    -    -
Total cash proceeds from buy-back  4.95  4.95  4.95
Value of capital loss (4)  0.02  0.19  0.53
Analysis of sale on-market
Capital Gains Tax calculations
Sales proceeds (5)  5.70  5.70  5.70
Less: Assumed cost base -3.00 -4.00 -6.00
Net capital gain/(loss)  2.70  1.70 -0.30
Net tax payable on capital gain (3) -0.47 -0.29  -
Total cash proceeds
Sales proceeds  5.70  5.70  5.70
Less: Net tax payable on capital gain (3) -0.47 -0.29  -
Total cash proceeds from selling on-market  5.23  5.41  5.70
Value of capital loss (4)  -    -    0.05

Assumptions:
(1) Telstra share price is \$5.70 and buy-back discount is 10%
(2) Individual in 32.5% marginal tax bracket (plus 2% Medicare Levy)
(3) Capital gains discounted by 50%
(4) Capital loss can be offset against capital gains (at same tax rate)
(5) Brokerage not included

A benefit only arises to a 32.5% bracket taxpayer if they’ve got a high cost base in their Telstra shares and non-discounted capital gains to offset. But even then, the benefit is likely to be fairly marginal unless there’s a tax rate increase on top.

### 5 day VWAP

One final point that all shareholders should note (including super funds) is that the buy-back price is calculated based on the volume weighted average price (VWAP) over the 5 trading days prior to the offer closing. Telstra will make a running estimate of VWAP available on their website (see also section 2.15 of the offer booklet).

The market price established by the VWAP calculation should roughly match Telstra's quoted share price although it's possible they could be quite different. So it's worth keeping an eye on Telstra's website and adjusting your calculation of the off-market buy-back benefit by the amount of the difference.

### Final words

Table 6 summarises off-market buy-backs versus selling on-market for each of the shareholder types we’ve examined.

Shareholder General rule of thumb? Main exceptions
Table 6: Off-market buy-back for various types of shareholders
Pension mode super fund (0% tax) Widely attractive       N/A
Accumulation mode super fund (15%) Attractive where buy-back discount less than maximum or where super fund has non-discounted capital gains to offset. Funds with higher cost bases that have no use for capital losses generated by buy-back.
Company (30%) Attractive where buy-back discount less than maximum. Companies with higher cost bases that have no use for capital losses generated by buy-back.
Individuals (0% to 45% plus levies) Attractive to those below tax-free threshold and those on 19% (plus ML) bracket if they use capital losses arising from buy-back in later years at higher tax rate, or where buy-back discount set very low. Those on higher brackets (eg 32.5% (plus ML)) can potentially benefit if they have non-discounted capital gains or are likely to be on a much higher tax rate when capital losses arising from buy-back are used.

In many cases it’s complicated. But at least now you know the ingredients to take the opportunity – either now, or in the future – if it arises. If you’ve got further questions, or scenarios we haven’t contemplated, please let us know through the Q&A function.