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Good Day,
Q1.
I have some doubts relating to the validity of the following advantage of scrip dividends as stated in the Kaplan Study Text.
“Shareholders may get a tax advantage if dividends in the form of shares rather than cash.”
Isn’t script dividends treated as taxable income as a cash dividend in the UK? If so, should the shareholder be indifferent as to whether or not cash dividends were paid? I’m confused here.
Q2.
Also, is this disadvantage of a scrip dividend correct?
Lets say the shareholder takes the cash dividend instead. As such, his shareholding will remain the same whilst the number of ordinary shares in the company would have increased from those other shareholders which accepted the scrip dividend. As a result, this shareholders ownership in the company would have become diluted due to the increased # of ordinary shares. Additionally, that said shareholder would also receive less dividends in the future on his shareholding due to the dividend per share reducing from the additional ordinary shares.
Thank you.
1. Scrip dividends are treated as taxable income and so generally there will not be a tax advantage. (Although there can be special circumstances as to the amount taxed is the market value is a lot difference than the cash equivalent – but this is beyond the scope of Paper FM).
2. What you write is true, although in theory (forgetting tax) the net affect on the shareholder (i.e. more cash now, but less dividend in the future) should be the same. Don’t forget that assuming some other shareholders will take shares, the company will be able to invest more and therefore total dividends in the future will increase.
More important for the exam is the advantage for the company of scrip dividends – they are a way of effectively raising more money from shareholders with no issue costs (by retaining the dividend that would otherwise have been paid) while at the same time giving shareholders the choice (certain shareholders will be relying on receiving cash dividends).
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