ANZ CEO John McFarlane is much better off by taking shares rather than a cash salary. This is due to the tax deferral and the magic of compounding returns. McFarlane is simply displaying the financial savvy we should expect from a bank CEO and someone prepared to back his own abilities.

For simplicity let’s assume he gets a salary of $5 million in 2005 and that ANZ shares increase by 20% a year for the next 10 years.

Option 1: He takes the salary in $5 million of shares in 2005. No tax is paid on these until the end of the deferral period. If we assume this is the maximum 10 year period, in 2015 these shares will be worth $31 million. Tax is paid at 47% on the full $31 million. Pays $14.6 million tax, but still left with $16.4 million.

Option 2: He takes the salary in $5 million cash, but pays $2.35 million tax in 2005, leaving $2.65 million. To make the direct comparison, assume he invests this amount in ANZ shares. In 2015 these shares will be worth $16.4 million. After paying CGT on the sale [$16.4 – 2.65 x 0.235] he’s left with $13.2 million.

So he’s over $3 million better off going with Option 1, and that’s before taking into account the bigger dividend stream from Option 1, and the fact that the way things are going with the tax debate, the top marginal rate may well be a lot less than 47% in 2015. Has Cossie told him something we don’t know?

The interesting point is, of course, that he also pays a lot more tax in Option 1, so everyone’s a winner. Essentially the ATO becomes an investor in ANZ for 10 years, which is surely a better punt than Telstra!

(Please note that I’ve simplified the tax calculations – no Medicare Levy, and flat rate of 47% – but the end result is basically the same given the big numbers involved. The $6,000 tax-free threshold doesn’t really help these guys much.)