A tax expensive option to reward shareholders
We have found that private listed companies where promoters hold over 65% stake, have a dividend payout ratio of over 100%
With rising profits amid a subdued economic environment, companies have limited options to invest in expanding capacities. Hence, the options available to use surplus cash would be to either opt for share buy-back or pay dividend.
While buy-back is a tax-effective option compared to dividend, promoters with a healthy holding may opt to announce a hefty dividend to enable some cash to return to their kitty proportionate to their holding.
Moreover, under the companies Act, buy-back is restricted to 25 per cent or less of the total paid-up equity capital and needs a special resolution provided it is not above 10 per cent of the paid-up equity capital. There is a also a time-gap of 12 months to be left between two buybacks of a company.
Having said that, in an economic down turn, where distress assets are up for the taking, promoters of a company are more than happy to announce dividends to bid for such assets, though it comes at a heavy tax-outgo.
From a high net-worth individual’s as well as promoter’s perspective, dividend distribution tax (DDT) is levied at 20.90 per cent on dividends payable by the company. Moreover, the individual shareholder receiving dividends in excess of Rs.10 lakh annually will have to pay a tax on such excess dividends at 11.85 per cent (10 per cent plus surcharge and cess, if the income exceeds Rs.1 crore). So overall, the dividend in such a case would attract almost 32.75 per cent tax, which is about the same rate as any other income.
There is also a strong correlation between promoter holding and dividend payout ratio. Over the past two years, we have found that the private listed companies where promoters hold more than 65 per cent stake, have a dividend payout ratio of over 100 per cent. Further, the proportion of dividend payout has increased significantly in the last fiscal compared to the previous few years.
On the stock performance front, the share price of such companies has given more than 100 per cent return during the last five fiscals (FY12–FY16). This indicates that companies with substantial holding by promoters’ tend to declare high dividend outgo to enable them garner a major portion of the cash pie.
To conclude, despite being high on taxes, dividend payout has been able to create better perception about the company in the minds of the retail investors in particular and others in general. This also helps in having a balance set of retail, domestic institutions and foreign institutions as stakeholders, that invariably brings down the cost of investor services for the company at large.
(The writer is president, Choice Broking