Scrip dividends are taxable in most cases as cash dividends. However, these special dividends offer shareholders a chance to retain additional stocks and avoid immediate tax liabilities.
Let us discuss what are scrip dividends and their tax treatment in different scenarios.
What are Scrip Dividends?
Scrip dividends are new stocks issued to shareholders by a company in the form of a certificate instead of cash.
Shareholders hold the right to receive cash against these certificates or take additional stocks. The conversion into cash comes with a holding period usually. It means shareholders cannot immediately receive cash.
So, scrip dividends work similarly to stock dividends with a difference of choice to receive cash or new shares. Shareholders receive additional shares with stock dividends and later can sell these stocks but do not receive them as an option from the company.
Shareholders receive scrip dividends in proportion to their existing shareholding. For instance, if the company announces a 1% scrip dividend, it means a shareholder with 500 shares will receive 5 scrip stocks.
The shareholder will then have the choice of keeping these 5 additional shares or converting them into cash at a specified date with the fair market value of the shares on that date.
Are Scrip Dividends Taxable?
The scrip dividends are usually announced in the form of certificates and hence are not taxable at the time of issuance.
Generally, if you receive a certificate for scrip dividends that offers you fractional shares in proportion to your ownership, it will not be taxable.
If the company announcing a scrip dividend converts these additional stocks for you, you’ll receive the net gains or losses. So, it will be counted in your taxable income but taxed at the source when announced.
On the other hand, if the company issues a certificate that entitles you a conversion to cash, it will be considered taxable income as and when received.
It means strip dividends convertible to cash are taxable when issued and those non-converted will be treated as non-taxable at the time of issuance.
As the shareholder receiving scrip dividends has a choice to convert scrip stocks into cash later, it will count as taxable income when converted anyway.
Scrip Dividends Taxes in the US
The IRS guides the tax treatment of scrip dividend income received by individuals. The rule states that a taxpayer must include the scrip dividends at fair market value when received.
This condition applies to scrip certificates with an option for the taxpayer to convert stocks into cash. If the certificate entitles the company to conversion and not the taxpayer, it will not be accounted for as taxable income immediately.
In that case, the taxpayer will only include the gain or loss made on the conversion through the transaction and report it to the IRS in tax returns.
So, the taxable scrip dividends will act like stock dividends with the following conditions:
- The shareholder has the right to receive cash or other property instead stocks.
- The dividend announcement gives cash to some shareholders and an increase in the ownership stakes to others.
If the shareholder does not convert the scrip certificate for one year, the conversion will be accounted for as capital gains. So, the gain or loss on the conversion will be taxable like capital gains after one year.
Scrip Dividends Taxes in the UK
The tax treatment for scrip dividends under the UK tax laws is also similar to the US. The taxpayer must assess the conditions put forward the scrip dividend certificate first.
If the taxpayer keeps the scrip certificate and does not convert it into cash immediately, it will be accounted for as capital gains when converted. Therefore, there will be no tax impact at the time of issuing scrip dividends.
Taxpayers receive a tax-free allowance of up to £ 5,000. Companies issuing scrip dividends usually do not withhold taxes at the source though.
Then, UK taxpayers above that threshold tax allowance of £ 5,000 will pay dividend taxes at the following rates:
- 7.5% dividend tax for those with a base income tax rate of 20%.
- 32.5% dividend tax rate for those with a base income tax rate of 40%.
- 38.1% dividend tax rate for those with a base income tax rate of 45% or above.
Non-UK residents will pay taxes on scrip dividends according to their local tax regulations and they’ll be subject to no taxes in the UK.
How to Report Scrip Dividend Income?
When a taxpayer receives scrip dividend income above $10, the income should be reported on Form 1099-DIV on stocks you hold.
Even when the taxpayer does not receive a Form 1099-DIV, the income should be reported on it at the time of filing tax returns with the IRS.
Otherwise, report the income on Form 1040 or Form 1040-SR whichever applies to you. Both these forms contain the same information and schedules though.
If the scrip dividend income is above $1,500, you must fill the Schedule II of Form 1040 as well. You’ll also fill this section if you received dividend income as a nominee on behalf of someone else.
Similarly, when you hold scrip certificates for one year and convert them as capital gains, you’ll report this income on Form 1040 or Form 1040-SR directly.
Why Do Companies Issue Scrip Dividends?
Companies issue scrip dividends to save cash generally. It is commonly used by companies when facing a cash crunch and also needs to satisfy customers with dividend income.
A scrip dividend will increase the share capital of the company without issuing cash. So, the company can preserve cash as most shareholders would hold the additional shares for keeping the same stakes.
The company can avoid negative sentiments about its share price by announcing a scrip dividend even when it does not hold sufficient cash. Therefore, the company can expect to control the share price as well.
Then, it can satisfy its shareholders as they get a chance to either retain additional stocks or convert them into cash. If planned well, a scrip dividend announcement can work well for a company in a cash-crunch situation without incurring additional debt for dividends.
What are the Benefits of Scrip Dividends for Shareholders?
First of all, shareholders can save taxes if they opt to keep the additional shares and do not convert them immediately. Capital gains tax rates are usually more beneficial for shareholders than cash dividend income tax rates.
Then, shareholders can opt to keep the same ownership stakes in the company. It means they can avoid the dilution of shares by not converting the shares.
Dividend shareholders usually seek regular cash income. A scrip dividend announcement can help them satisfy cash needs through a choice of conversion.
The only drawback here is that shareholders must retain scrip dividends up to a certain date. The conversion date is set by the company with a delay after announcing a scrip dividend usually.
An optimal policy for most shareholders can be to hold a few stocks and convert a few to fulfill their cash needs.
Disadvantages of Scrip Dividends
Some drawbacks of scrip dividends for the company and shareholders include:
- It may send negative sentiments in the market about company performance and the non-availability of cash for dividends.
- Share prices may increase by the due date and if the majority of shareholders convert, it can prove costly for the company.
- Even when shareholders retain additional shares, it will dilute their earnings per share in the future.
- Shareholders may have to pay more taxes on scrip dividend income than they would otherwise in some cases.
