The potential for the rebirth of the scrip dividend

United Kingdom

Mark Nichols plots the potential for the rebirth of the scrip

The latest Finance Act confirms the demise of the repayable tax credit, immediately for pension funds and from April 1999 for others including PEPS. Some say that this has been inevitable. Lamont started the process by cutting the tax credit. Look at the US lesson - their equity investments are now made for capital gain, their income tax rules being so punitive.

In this context it will be no surprise to see the rebirth of the old faithful scrip dividend (cash dividend with share alternative). Historically the scrip dividend has not been popular. It has had a very low take-up amongst shareholders due to unattractive tax consequences. In the early 1990's the enhanced scrip dividend ensured a high take up of the share alternative by grossing-up the value of the shares offered as the alternative to the lower cash dividend.

Tax advantage of scrip

With the abolition of the refundable tax credit for pension funds, it can readily be seen that the disadvantage of a scrip dividend in relation to which no refundable tax credit arises in any event are much diminished and certainly from 1999 the ACT saving for a number of companies, particularly multi-nationals, will give scrip dividends a positive tax advantage. This will be even more the case following the termination of the FID regime (although the Government has announced that it will make amendments in next year's finance bill following consultation with interested parties).

If the enhanced scrip dividend was popular in the early 90s as the ACT mountain of some multi-nationals became unmanageable, then surely the more straight-forward scrip dividend must now come into its own.

It should however be borne in mind that the ACT advantage is somewhat illusory in that a scrip dividend is in effect a rights issue which dilutes the existing equity and goes to increase the number of shares on which dividends must be declared in the future.

Redesignation of share capital

As an alternative to the scrip dividend, companies making one off cash distributions will be looking even more keenly than before at the possibility of a cancellation or reduction of capital. A number of companies have already set about the repatriation of share capital to investors. Those with a high share premium account have found it easy through bonus issues of preference shares. Those with high share capital and low share premium have found it more difficult and a number of complex schemes have grown up involving the redesignation of the existing ordinary share capital into ordinary shares and preference shares with the company offering to buy back the resulting preference shareholdings at their nominal value.

These schemes have the advantage of not giving rise to an ACT liability as they represent a repayment of original issue capital or premium. They are treated as on capital account for the shareholder recipients. Thus pension funds will as with a dividend receive a tax free return.

In terms of the treatment of individuals, higher rate shareholders may prefer not to receive scrip dividends as they are subject to higher rate tax in their hands and may necessitate a sale of the resulting shares in order to pay the tax bill. On the other hand the receipt of a one-off repayment of share capital or premium may well be tax free in the hands of the higher rate taxpayer who has not used up his annual capital gains tax exemption (should that survive future Labour government budgets!).