The peculiarity of special dividends

Nov 20, 2019 | Tony Byrne's View

I have long since wondered why companies pay one-off so called special dividends to shareholders. I am not a big fan of special dividends. In fact I am not a particular fan of dividends per se.

Why is this? I hear you ask.

Well although dividends are not officially classed as business expenses they are nonetheless a cashflow expense of a company which UK PLCs are expected to pay typically once or twice a year. It is a similar situation in the United States though the large technology companies do not usually pay dividends.

As dividends typically represent a third of a company’s profits they are a serious drain on a PLC’s cash reserves. Furthermore dividends are taxed on investors at penal rates of Income Tax unless they are basic rate taxpayers (7.5% tax) or only own a small number of shares which produce less than £2,000 a year in dividends in which case they are tax free. If they are received in a tax wrapper such as an ISA or a pension then they are tax free otherwise they are taxable. For example higher rate taxpayers pay a rate of 32.5% Income Tax on dividends and additional rate taxpayers pay 38.1%. Ouch.

On the hand Capital Gains Tax on capital gains from selling shares is taxed at a rather benign rate of just 10% for basic rate taxpayers and 20% for higher rate and additional rate taxpayers. Furthermore each individual is entitled to a tax free annual CGT exemption of £12,000.

So from a serious investor’s point of view capital gains are far more preferable than dividends for tax planning purposes.

From the company’s perspective it appears that special dividends are usually paid when the company has built large cash reserves and doesn’t have better ideas what to do with the surplus. Special dividends are also used strategically by companies when they wish to restructure. A good recent example of this is the proposed merger between Fiat Chrysler and Peugeot, PSA, which will involve paying one-off special dividends to both Fiat Chrysler and Peugeot shareholders.

The advantage of special dividends is that the company doesn’t come under pressure to repeatedly pay them because they are one-off distributions unlike regular dividends.

One of the disadvantages of special dividends is that the amount paid in dividends immediately reduces the value of the shares by the same amount. A further disadvantage is that investors may become suspicious that management lacks ideas how to invest to grow the business or may simply be suspicious of the executives’ motives which can, and does, lead to subsequent periods of underperformance of the shares.

Microsoft suffered from this issue in 2004 when they paid a particularly high special dividend of $32bn out of a cash reserve of $50bn. Of course owners with large stakes in these companies receive relatively large personal dividends on these occasions. Bill Gates personally received a special dividend of $3.3bn on this occasion. So the personal interest of company owners is a further issue to consider.

Interestingly the amount of money spent by companies on special dividends is rising. I am not at all convinced this is a good thing but only time will tell.

In Asian countries the philosophy is very different. As a rule companies simply do not pay dividends. They prefer to re-invest the money into their companies. None other than Richard Branson is a great believer in owning private companies rather than publicly quoted ones. One of the reasons for this is because he doesn’t believe companies should be paying away a significant amount of their profits in dividends to shareholders. I agree.

Whether you are interested in dividends or not it doesn’t really matter. However if you are interested in advice on investing then why not get in touch with us? You know it makes sense.

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