Make your
tax status count
with Raewyn Williams
Director, After-Tax Investment Strategies
In this Q&A, Raewyn Williams discusses the importance of making your tax status
count when finding the right investment solutions for your not-for-profit organisation.
It seems strange to be talking about tax in the context
of tax-exempt organisations. How is tax relevant to a
tax exempt organisation’s investment outcomes?
Yes, it does seem strange, but tax actually does impact the
investment outcomes of a tax-exempt organisation. Notfor-profit (NFP) entities typically can claim franking credits
received on dividends from Australian equities back from
the Australian Taxation Office as cash. Also, because
NFPs are tax exempt, they aren’t reimbursed for foreign
taxes deducted from international equity dividends so they
can end up paying tax after all – in the foreign country!
So… are these tax impacts significant to an NFP?
More significant than the NFP entity might realise. The
difference between an Australian equity portfolio managed
without valuing the franking credits and one that values the
franking credits for the NFP can be as much as 200 basis
points or 2% each year. In the context of average (prefranking) equity returns of around 3.9% over the past year,
this means there’s an opportunity to increase Australian
equity returns to an NFP by a half again!
The foreign tax leakage on international equity dividends
is also significant. For Australian and New Zealand NFPs,
it’s not uncommon to see investment returns reduced by
35 basis points or more each year. And the leakage can
be considerably higher for an NFP investing offshore into
certain other asset classes like property.
Given these numbers are significant, why do you
say the NFP may not be aware of them? NFPs, like
other investors, get investment performance reports,
after all.
The problem is that investment managers almost always
report returns to investors on a pre-tax basis. They don’t
report franking credit outcomes which are non-cash
items, even though NFPs can trade in every $1 franking
credit for $1 cash. So there’s nothing on the performance
report to alert the NFP investor to this opportunity or to
indicate how well the investment product or manager
performs on the franking credit piece.
Foreign withholding tax is similar: the leakage is
embedded within the returns reported so the NFP
investor can’t see the extent of the leakage or what the
investment product or manager is doing to manage the
leakage.
So it’s a matter of getting after-tax returns onto
investment performance reports?
Well, that’s a good start. The information will empower
NFP investors and their advisors to have a conversation
with investment managers about these tax issues and
opportunities.
October 2011
Make your tax status count
“The hardest
thing – and the
biggest insight!
– is realising that
NFP investors
want something
different to many
other investors
in the market”
What should be the outcome of these
conversations? What should NFPs be
getting from their investment products,
managers and advisors?
It starts, of course, with understanding your
client: the client’s mission, its investment
objectives, yield and liquidity needs, and other
factors. Most advisors wouldn’t add the NFP’s
tax profile to this list of basics, but we do at
Russell because it should influence the choice of
investment products and managers.
What you’re looking for is an investment
solution which manages an NFP’s portfolio in an
appropriate way: it is underpinned by good pretax value drivers, has good yield characteristics
(a portfolio’s capital growth doesn’t fund an
entity’s mission!), values franking credits and
minimises leakage from foreign withholding
tax and other taxes. On the flipside, the choice
of investment solution should recognise that
the NFP investor doesn’t value, at least not like
taxable investors do, things like low turnover
and capital gains tax management. So they
shouldn’t pay for these things!
How hard is it for NFP investors to find
after-tax investment solutions which fit their
tax profile?
The hardest thing – and the biggest insight!
– is realising that NFP investors tend to want
something different to many of the other
investors in the market. For example, they
care a lot more about the income/capital split
of a portfolio’s return – getting ‘total returns’
managed and reported doesn’t go far enough.
There needs to be a realisation that most
investment products and strategies aren’t built
with NFPs in mind. So the NFP investor has
a choice: stick with an investment solution
which isn’t bad by any means but is designed
for the ‘typical investor’ in the market who
values different things to the NFP; or move to
a solution well suited to NFPs – an investment
strategy which focuses on and delivers the
things that the NFP really values.
How should NFPs go about making the
most of this investment opportunity?
I’d recommend that governance drive this
change. That means getting NFP trustees
or governors to reframe their investment
objectives in after-tax terms to explicitly
recognise the value of franking credits and the
impact of invisible taxes like foreign withholding
tax. The right investment governance
framework will allow the right processes product or manager selection, asset allocation,
performance reporting - to fall into line with
these investment objectives.
It’s also a natural place to start for NFPs because
governance is such a key theme at the moment.
The Federal Government’s establishment of a
national framework under the new Australian
Charities and NFPs Commission will clearly
impact NFP governance. Even the ATO is onto
this trend, releasing an NFP self-governance
checklist last week.
Any last comments, Raewyn?
Just that investment outcomes have a direct link
back to the NFP organisation’s ability to fulfil its
mission on both a short-term and longer-term
basis. We learnt from last year’s Productivity
Commission report that investment outcomes
contribute, on average, less than 3% to an
NFP’s bottom line so we need to make this
capital work harder... or smarter. Having a
good fit after-tax investment solution for NFP
investors is key to this.
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October 2011
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