In just over 40 years of experience in the corporate world, I have seen, or heard of just about everything that Boards, Chairman, and Company Secretaries can get wrong. I will not disclose which ones I have person knowledge of, or which ones were told to me by other people. I don’t want to allow readers to guess the guilty culprits.
1. Be very careful about what goes in the Board Minutes
There was the case back in the 1920s in Australia. Back then, then was no capital gains tax unless there was a premeditated intent of making a capital gain on an investment. Naturally, everyone bought assets for their income alone, just like people still believe in the tooth fairy.
In this particular case, a family company was buying land on the outskirts of Melbourne, for the purposes of building a large chicken farm (pre battery hen days).
Dad, being the company chairman, put in the Board Minutes: “Anyway, if we don’t make any money out of the chooks, we can sell the land in 40 years’ time to a real estate developer, and make millions, and tax free as well!”
Guess what happened. Many years later, the next generation of the family did just that. It happened pre 1985 prior to dividend imputation, which effectively abolished double taxation of corporate income and capital gains. I am not sure of the value of the property, but let’s assume it was sold for $10 million, after being bought for say $10,000.
The Australian Tax Office ATO wanted to look at the minutes of past board meetings, as they are allowed to by law. When they saw the entry: “Anyway, if we don’t make any money out of the chooks, we can sell the land in 40 years’ time to a real estate developer, and make millions, and tax free as well!” their response was GOTCHA!
You also bought the land for the purposes of a capital gain. Company tax was then at the rate of about 46%. We will have $4.6 million thank you very much!
That left the family company with $5.4 million. But the story gets worse:
In the 1950’s private companies were taxed at 50% on un-distributed profits. This could have been avoided by paying a dividend, but as the tax marginal tax rate was 65%, it was better left in the company.
So the ATO took 50% of the remaining $5.4 million, leaving $2.7 million out of a potential $10 million tax free for the family, an effective tax rate of 73%
Moral from this True Story.
Minutes should simply say: “This matter was discussed and approved or disapproved as appropriate” The only other comment should not any individual directors’ disagreement with the decision if they insist.
2. What to do if you are a director, and you don’t understand something in the Board Papers.
Ring or meet with the Chairman. He may be aware of something else above the matter which is not in the Board Papers. He may answer your concern. Suggest that all members of the Board be advised of that issue at the board meeting. Never discuss board paper issues by email, as these are discoverable.
If the Chairman cannot answer your query, ask if you may meet or speak directly with the CEO. Again, no emails.
If you disagree with the answer you receive from the CEO about the proposal, ask him to withdraw it for more work. If he refuses, then advise both his and the Chairman that you will oppose the proposal at the board meetings, and you will give the board your reasons why you disagree.
3. What to do after the Board Meeting.
Insist that all board members leave the Board Papers behind at the end of the Board Meeting for shredding.
Once I was an investment executive I was putting together a complicated set of transactions. The reason was that following the 1987 stock market cash, we lost a lot of money on a “Cash covered SPI (Share Price Index Futures) transaction that gave a better return than buying pure shares due to a market arbitrage opportunity I has discovered.
The problem with tax losses in a Life Office Statutory Fund at the time, is that they effectively could not be carried forward. This was because they were offset against Premium Income, which was not assessable income.
My solution: I created a new subsidiary company wholly owned by that Statutory Fund. I then sold enough shares downstream into that company to realise enough capital gains to offset the capital losses. My argument in the Board Paper was that perhaps we could float off that share company one day, and turn it into a listed investment company, such as AFIC (Australian Foundation Investment Company Ltd)
One of the Executive Directors wrote on his board paper “For tax reasons” This copy of the board papers was discovered during a routine tax audit.
Bingo: Tax Office grabbed about $50 million off us.
Moral of this story:
Insist that all board boards leave the Board Papers behind at the end of the Board Meeting for shredding. Tell the directors they will always have access in the future, if required, for the Clean Board Papers
4. Never allow yourself as a director to be obfuscated by “mumbo jumbo in the Board Papers
A life office I knew of was trying to buy market share by crediting capital guaranteed policy holders an interest rate higher than what the underlying assets were earning.
These “shortfalls” were put in the Balance Sheet on the Assets side as Crediting Rate Spread. Not surprisingly, this number was negative.
The company secretary at that time told me what happened when a member joined this board. This question asked of the Chairman was: “Does this very large negative number in the Assets side of the Balance Sheet under the title “Crediting Rate Spread” mean that we have been that we have been paying out more than we have been earning?”
The Chairman, and the rest of the Board turned their eyes to the senior executives at the meeting with a look of concern and even fury.
Needless to say, there were a lot of very red executive faces after that.
Moral of this story:
As a director, never accept mumbo jumbo, and keep asking questions until you are satisfied.
If you are not satisfied, resign from the Board and quietly leave without making any public comment.
Peter A Worcester BA BSc FIAA MAICD
27 January 2017