The Telstra buyback – announced August 14 – will "cost taxpayers hundreds of millions of dollars", he said. The IPA is urging the federal government to review a tax rule that allows the artificial streaming of franking credits from taxpayers on high rates to those on low or zero rates who can cash in the credits. It views the system as inequitable and says it reduces options to fund other initiatives, especially in support of small business. Companies can reduce excess cash by repurchasing their shares at a discount to market price. The payment is split into a capital and a fully franked dividend component. The take-up of buybacks is skewed towards those on a low or zero tax rate – such as superannuation funds on 15 per cent and tax exempt charities – because they receive a rebate for company tax paid. Shareholders on a rate above 30 per cent must pay top up tax, making buybacks unattractive. "This is effectively streaming from high tax rate payers to low tax rate shareholders, so it's digging around the general principles," said Mr Greco.

For a $70 fully franked dividend, a tax-free entity would receive the $30 tax credit whereas someone on the top marginal tax rate would pay an extra $19. It's a $49 difference in government revenue. Less long-term impact Greenwoods & Freehills director Chris Colley said that although a large refund is generated in the short term, in the long term the impact is neutralised because companies must recognise a penalty debit to their franking account, cutting the amount of franking credits in the system. "In the long term, if you assume profits are eventually distributed, there's actually less refunded or no more refunded than if they'd simply paid out a dividend," said Mr Colley. The penalty debit is based on the amount of franking credits being distributed and the percentage of non-residents, on whom credits are wasted.

As long as the company is buying its shares at a discount of no more than 14 per cent, the Australian Taxation Office will reduce the company's franking account and let shareholders take the franking credits. Mr Colley noted that despite recent reviews of buybacks by the Board of Taxation and Treasury, no proposal to change the system has arisen. "No one within government has said 'we think this is such an outrage that we have to stop it'," he said. Those on a higher tax rate will pay more capital gains tax when they eventually sell the share, he added. "If you focus on the buyback in isolation it's easy to see this huge outflow in money but I think it's a lot more complicated than that in its revenue impact over the long-term."

But Mr Greco says that companies have "more franking credits than they physically have cash to pay out". "Companies awash with credits will still be able to frank dividends." And the Abbott government is under pressure to reign in the budget over the short term in its surplus drive. Secrecy provisions mean the penalty debits companies make to their franking accounts in a buyback are not public knowledge. In total around $1 billion was debited in the four years to mid-2007 in the franking accounts of listed companies.

The ATO says that the penalty debit compensates for the streaming of credits from non-residents to residents. Melbourne stockbroker Graham Sellars-Jones launched a campaign nearly a decade ago against buybacks for their discrimination against top-level taxpayers.