IMPACT OF DIVIDEND ON SHAREHOLDERS

by Komal Sanwal

COVID-19 has already dislocated many businesses, thereby affecting the job market. The only way to live at that point is to have a regular income. In such volatile times, investors tend to focus on dividend-paying stocks to be sure to make some money as they fear uncertain capital gains. 

If a company generates a profit and accumulates retained earnings, they either reinvest in the business or payout dividends to shareholders. 

Do you know what gives me the most pleasure? Seeing my dividends come in. 

-John D. Rockefeller 

Before issuing dividends, the management of a company must consider various factors, such as the number of earnings, the stability of earnings, the tax system, etc. 

Why should you invest in a company that announces dislocations across every industry, several people are out of work? Why should you invest in a company that announces regular dividends to its shareholders? 

Suppose you’ve invested in the stocks of a company for at least the next 20-25 years. If the company does not pay dividends, even though your net worth is increasing, you would not be able to make money until you sold your shares. Your investment value is growing, but you won’t receive any cash until you sell.  

If, however, the company you own gives a regular dividend, say 3-4% per year, then you are receiving a return on your investment. Here, your capital is growing since you have not sold your stocks. A company that announces regular dividends is considered to be financially sound. Investors are therefore more likely to invest in it.

Types of Dividends 

There are typically FOUR types of dividends.

Cash Dividend: are paid directly in money to a shareholder. For eg, on February 1, XYZ LTD’s board of directors declares a cash dividend of 2 Rs per share on the company’s 2,000,000 outstanding shares, to be paid on Jan 26 to all shareholders of record on Jan 10. After Jan 26 within the next few days, all the shareholders will receive the money in their linked bank accounts. 

Stock Dividend: unlike cash dividend, in-stock dividend, a company gives shares rather than cash as a dividend. If the company issues less than 25% of the previously issued stocks then it will be treated as the stock dividend. 

Hybrid Dividends: are a mixture of cash payout with stock payout. For eg, you own 100 shares of XYZ LTD. The company declares a stock-and-cash dividend of 30 p per share, plus 10% of the shares owned. The investor would receive an Rs.30 cash dividend and 10 additional shares of XYZ stock. The investor may well feel as if he’s getting a better deal by receiving both types of dividends.

Property Dividends: are the dividends paid to investors in the form of assets with monetary value. For eg, ABC LTD has 1,000 shareholders. The company owns 1,000 signed Warhol prints, which it has stored in its vault for many years. The fair market value of the prints is Rs.1,000,000. The company decides to distribute one print to each of its shareholders. Each print is worth Rs.1,000. The shareholder may decide to sell the print, or he may wish to hold onto the print for additional, long-term capital gains. 

Taxation Policy 

Earlier companies used to deduct dividend distribution tax (DDT) before declaring a dividend to investors. Therefore, the dividend received was tax-free in the hands of the investors, while those who received dividends over Rs10 lakh were taxed at 10%. The dividend was to be shown under ‘Exempted Income’. 

From FY20-21, the government has made dividends distributed by a company taxable in the hands of the investors. Now it should be shown under ‘Income from other sources. The company is required to deduct Tax Deducted at Source (TDS) at the rate of 10% in cases where the dividend paid or payable for the financial year is more than ₹5,000. 

Deduction of expenses from dividend income: However, the Finance Act, 2020 provides for deduction of interest expense incurred against the dividend. The deduction should not exceed 20% of the dividend income received. 

For eg, Your dividend income is Rs. 50,000, we are only allowed an expense deduction of 20% i.e., Rs. 10,000. However, you are not entitled to claim a deduction for any other expenditure like commission or salary expense incurred for earning the dividend income.

Highest Dividend Paying Stocks in India 2020

CompanyITCPower GridCorporationTech MahindraGAILBajaj Auto
Dividend Yield (%)5.193.282.196.563.85
Payout Ratio (%)55.9843.4332.4224.5866.63

CONCLUSION

Dividends are a great source of passive income. Dividends provide a regular income stream. The best thing about dividends are we are only expected to hold the shares of a company and just watch the amount getting credited to our account. Who doesn’t like that? 

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