Scrip Dividend Meaning
Scrip dividends, also known as liability dividends, are issued by the company to its shareholders in the form of a certificate instead of a cash dividend that provides a choice to its shareholders to get dividends at a later time, or they can take shares in place of dividends. Companies issue dividends when they have insufficient cash to pay as a dividend.
Scrip dividend is not taxable at the time of receipt. However, it will be taxable at the time of the sale of shares. It means capital gain tax will apply in scrip dividends in the case of dividend income tax.
Table of contents
- Scrip dividends are also known as liability dividends. Instead of a cash dividend, the corporation gives certificates to its owners, allowing them to redeem them for shares or future dividends.
- When a company lacks the cash to pay a dividend, it will issue dividends.
- The Board of Directors proposes a scrip dividend.
- It is not taxable at the time of receipt. Therefore, it will be taxable during the selling of shares. It means capital gain tax may apply in scrip dividends in dividend income tax.
Scrip Dividend Explained
A scrip dividend is issued by the company when the company wants to give a dividend. Still, it does not have the cash to pay dividends, or it wants to invest the available cash for the growth of the business, capital expenditureCapital ExpenditureCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year., or any other purpose. But at the same time, it gives a negative sign to the market about the company.
Investors do not want to invest in the company because they are not getting a cash dividend. They feel their money will get blocked as the company’s financial condition is not well or it does not have a cash crunch. Sometimes the company’s share price is also reduced.
It is one of the types of dividend in which dividend is paid in the form of shares rather than cash. In this type of dividend, the company issues promissory notesPromissory NotesA promissory note is defined as a debt instrument in which the issuer of the note promises to pay a specified amount to a party on a particular date. to the shareholders. They create notes payableNotes PayableNotes Payable is a promissory note that records the borrower's written promise to the lender for paying up a certain amount, with interest, by a specified date. on which interest will be included or not.
How To Calculate & Issue?
A scrip dividend scheme is an important element when it comes to shareholders having something that they can encash or use at a later stage. As a result, it is important that organizations calculate the shares and issue dividends in the form of certificates with no error. A doubt in a shareholder’s mind will lead to distrust, harming an entity’s reputation.
Let us discuss the process of issuing this dividend in detail –
- First of all, the board of directorsBoard Of DirectorsBoard of Directors (BOD) refers to a corporate body comprising a group of elected people who represent the interest of a company’s stockholders. The board forms the top layer of the hierarchy and focuses on ensuring that the company efficiently achieves its goals. will propose a scrip dividend.
- A shareholderShareholderA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares. will approve the proposed dividend in the annual general meeting. Then only it can be given to shareholders. In AGMAGMAGM stands for annual general meeting. It is an official gathering of the stockholders and directors of an incorporated company in every calendar year to ensure that there is 100 percent compliance concerning all the lawful requirements like preparation and presentation of its financial statements., shareholders can modify the proposal the board of directors presents.
- The AGM record date will be finalized.
- They will be issued to only those shareholders who hold shares on the record dateRecord DateThe date of record for dividends is the cut-off date decided by the top management for the investors to get registered as a stockholder in the company's books to get the dividend payment on their security holdings. or whose names will appear in the company’s share register.
- The company will finalize the reference price, which is generally five days average of the stock’s closing price according to the stock exchange where the stock is listed from the date of ex-dividend.
- The company will now issue sharesIssue SharesShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner's equity on the Company's balance sheet. to shareholders as scrip dividends:
The formula used for scrip dividend calculation is mentioned below:
No far as scrip dividend tax is concerned, the shares will not be taxable at the time of receipt, like in cash dividendCash DividendCash dividend is that portion of profit which is declared by the board of directors to be paid as dividends to the shareholders of the company in return to their investments done in the company. Such a dividend payment liability is then discharged by paying cash or through bank transfer. but will be at the time of sale as capital gain tax, which is generally lower than the dividend income tax.
Let us consider the following examples to check what is scrip dividend and how it works:
Example 1 – Basic
Suppose a shareholder owns 1000 shares, and the company paid one share against 50 shares owned by a shareholder. Here, the investor will get 20 shares as a scrip dividend.
Example 2 – Advanced
If a shareholder holds 1000 shares and the dividend per share was $20 per share declared by the company and the reference price of the claim is $800 per share, then the shareholder will receive 25 shares under the scrip dividend scheme. How? Let us find out:
Calculation of scrip dividend can be done as follows:
- No. of shares held at the record date of DividendsRecord Date Of DividendsThe date of record for dividends is the cut-off date decided by the top management for the investors to get registered as a stockholder in the company's books to get the dividend payment on their security holdings. = 1000 Shares
- Cash dividend per share = $20
- Reference price of share = $800
No. of Shares Under Scrip Dividend = 1000 Shares* $20/$800 = $20,000/$800 = 25 Shares
A scrip dividend is a tool that proves beneficial for both those who issue shares and also those who invest in them.
Some of the advantages are as follows:
- The company does not require paying cash immediately or later if shareholders opt for taking shares, and the company can use this cash for capital investmentCapital InvestmentCapital Investment refers to any investments made into the business with the objective of enhancing the operations. It could be long term acquisition by the business such as real estates, machinery, industries, etc..
- Shareholders can increase their shareholding without incurring any extra transaction costs.
- It will increase the company’s total share capitalTotal Share CapitalShare capital refers to the funds raised by an organization by issuing the company's initial public offerings, common shares or preference stocks to the public. It appears as the owner's or shareholders' equity on the corporate balance sheet's liability side..
- Shareholders can take the tax advantageTax AdvantageTax Advantage are the types of investments or saving plans that benefit tax exemption, deferred tax, and other tax benefits. Examples include Government bonds, Annuities, Retirement Plans. if the dividend is in the form of shares.
- The share price will not change much in case of the issue of the scrip dividends.
- This type of dividend gives extra time to the company, which is the difference between the dividend declaration date and payment date.
Undoubtedly, the scrip dividend scheme has many advantages, but there are demerits too that both organizations and shareholders need to know.
Some of the disadvantages are as follows:
- It is not a good sign for the company as investors and other stakeholders will think it has a cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. issue.
- If shareholders are required to pay tax on dividends, they have to sell some shares because, in this dividend, they do not receive cash.
- If the share price increases, the company has to pay an excess dividend compared to the dividend declared.
- There will be no growth in shareholders’ wealth because earning per shareEarning Per ShareEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is. and share price will decrease after the scrip dividend issue.
Frequently Asked Questions (FAQs)
In a scrip dividend, the shareholder can receive the dividend as cash or additional shares. In comparison, in a stock dividend, there is no option. Instead, the shareholder obtains an additional share.
The dividend income obtained more than the dividend allowance is taxable. The dividend income received by individual shareholders who are liable to income tax at the basic rate of 20% must pay the tax at the basic dividend rate of 7.5%.
Any cash payment is taxed as a cash dividend. A non-UK resident shareholder is subject to tax on any amount carried forward as a residual dividend entitlement under any law to which that person is outside the UK.
ACS, Banco Santander, Barclays, BP, ComputerShare, HSBC, Iberdrola, National Grid, Pennon Group, Rolls Royce, South Side Bank Share, and Royal Dutch Shell offer scrip dividends.
It has been a guide to Scrip Dividend & its Meaning. Here, we explain the concept with examples, advantages, disadvantages, and how to calculate and issue. You may also take a look at some of the valuable accounting articles here:-