Capital dividend is a type of dividend paid by a company to its shareholders from the company’s capital. This dividend is paid from the company’s surplus and is not sourced from the company’s profits. Capital dividends are not taxable to the shareholders as they are not considered income, but are instead treated as a return of capital. Companies typically pay capital dividends following a large asset sale, in order to pass on the proceeds of the sale to the shareholders. Capital dividends can also be paid when the company has a large amount of capital and wants to distribute it to the shareholders.
Example of capital dividend
- ABC Corporation has a large sale of assets resulting in a substantial amount of capital. The company then decides to distribute this capital to its shareholders in the form of a capital dividend. The dividend is not taxed to the shareholders, as it is treated as a return of capital.
- XYZ Corporation has a large amount of capital and decides to distribute it to its shareholders in the form of a capital dividend. This dividend is not taxable to the shareholders, as it is considered a return of capital. The dividend can be used by the shareholders for investments or other purposes.
Types of capital dividend
Capital dividends come in a variety of forms. These include:
- Share buybacks: A company may offer a share buyback, which is when the company buys back its own shares from shareholders. This is a way to return capital to shareholders without having to distribute a dividend.
- Property dividends: Property dividends are when a company distributes physical property, such as land, to its shareholders.
- Liquidation dividends: Liquidation dividends are paid out when a company is liquidated and is the last form of dividend that is paid out.
- Stock dividends: Stock dividends are when a company issues additional shares to its existing shareholders.
- Special dividends: Special dividends are one-time payments that are made in addition to regular dividends. These are usually issued when the company has experienced a large windfall or has made a large asset sale.
Advantages of capital dividend
Capital dividends offer a number of advantages for companies and shareholders. These advantages include:
- Tax Benefits - Since capital dividends are not considered income, they are not taxed in the same way as income dividends. This means that shareholders can receive more money from capital dividends than from income dividends, as there are no taxes to be paid.
- Increased Shareholder Value - By distributing capital dividends to shareholders, the company is essentially returning capital back to the shareholders. This can increase the value of the shareholder's stock and can have a positive effect on the company's stock price.
- Increased Shareholder Control - By distributing capital dividends, shareholders can have more influence over the company's decisions. As the shareholders are essentially receiving a portion of the company's capital, they can use their newfound resources to influence the company's future in terms of investments, acquisitions and more.
- Increased Liquidity - By distributing capital dividends, the company can increase its liquidity. This can be especially helpful for companies that are looking to pay down debt or invest in other assets.
Limitations of capital dividend
Capital dividends can be a great way for a company to return cash to their shareholders, however there are some limitations associated with them. These limitations include:
- The company must have a sufficient amount of capital to distribute, as the capital dividend is paid from the company’s surplus and not its profits.
- The dividend is not taxable for the shareholder, as it is treated as a return of capital. As a result, the shareholder does not realize any additional income from the dividend.
- Capital dividends are not a regular source of income for the company, as they are typically only paid after the sale of a large asset or when the company has a large amount of capital to distribute.
- Capital dividends may not be available in all jurisdictions, as some countries do not allow them.
- Companies may be subject to certain restrictions or regulations when paying capital dividends, depending on their jurisdiction.
There are several other approaches related to capital dividends that can be considered by companies. These include:
- Distributing capital gains: Companies can distribute capital gains to their shareholders, which is a type of dividend that is paid out of capital gains from the sale of assets or investments. This dividend is taxed as income to the shareholders.
- Share buybacks: Companies can buy back their own shares, which reduces the total number of outstanding shares and increases the value of the remaining shares. This is an efficient way for companies to return capital to shareholders without actually paying a dividend.
- Share splits: Companies can split their shares, which increases the total number of shares outstanding and reduces the value of each share. This can be a way to return capital to shareholders while also increasing the liquidity of the shares.
In summary, there are several approaches related to capital dividends that companies can consider. These include distributing capital gains, share buybacks, and share splits. Each approach has advantages and disadvantages, and companies should consider all of these options before deciding which approach to take.
- Brockman, P., & Unlu, E. (2011). Earned/contributed capital, dividend policy, and disclosure quality: An international study. Journal of Banking & Finance, 35(7), 1610-1625.
- Aivazian, V., Booth, L., & Cleary, S. (2003). Dividend policy and the organization of capital markets. Journal of multinational financial management, 13(2), 101-121.