Definition
A capital dividend, in finance, refers to a type of payment an organization can give to its shareholders from its capital profit, which typically stems from the sale of a non-depreciating asset. This type of dividend is tax-free because it’s considered a return of capital rather than a profit distribution. It’s commonly used in companies that have sold off assets or realized significant capital gains.
Key Takeaways
- Capital Dividend refers to a type of payment to shareholders that originates from a company’s capital profits, rather than its earned income. This type of dividend is typically tax-free for the receiver because it’s considered a return of capital instead of an income.
- Capital Dividend Account (CDA) is an account which tracks the amounts that can be paid out as capital dividends. Certain types of income increase the balance within the CDA, including life insurance proceeds and non-taxable portion of capital gains.
- Decisions on whether or not to distribute capital dividends are typically made by a company’s board of directors and depend on the company’s financial health. Thus, capital dividends can provide valuable insights into a company’s financial state and strategy.
Importance
A Capital Dividend is an important financial term as it refers to a type of payment made by a firm to its shareholders, that is drawn from the company’s capital base, or profits from the sale of a capital property or fixed asset, rather than from retained earnings.
This often tax-free dividend allows companies to return money to shareholders without causing a tax burden on their part, making it an advantageous strategy for both the company and the shareholders.
This approach can be particularly beneficial in enhancing shareholder value and can also act as a key incentive for potential investment.
Therefore, understanding capital dividends is crucial for both businesses to manage their financial strategy and for investors to make informed decisions.
Explanation
A capital dividend serves the purpose of distributing tax-free money to shareholders. This is utilized in countries like Canada where the taxation system enables tax-free disbursement through the Capital Dividend Account (CDA). It’s an account where a corporation may accumulate its non-taxable surpluses and this account balance can be paid out to shareholders as a capital dividend, without having them pay income tax on this dividend.
Typically, these non-taxable surpluses could result from a life insurance policy receipt, the non-taxable portion of capital gains, or certain other surpluses. This type of dividend is beneficial for shareholders as they do not have to pay taxes on the income received.
The use of a capital dividend is valuable in overall financial planning and in enhancing shareholders value. It essentially provides a tax-efficient method of distributing cash to shareholders.
Furthermore, it contributes to a company’s capital management strategy, allowing for a formalized process of returning excess capital to shareholders while maintaining a desired capital structure for the company. In summary, the purpose of a capital dividend lies in maximizing shareholder value by distributing non-taxable surpluses in a tax-efficient manner.
Examples of Capital Dividend
Microsoft Corporation: In December of 2004, Microsoft Corporation issued a special one-time capital dividend of $32 billion to its shareholders. The corporation had a huge amount of cash on its balance sheets and instead of investing it in projects or acquiring other businesses, they decided to return some of it to the shareholders in the form of capital dividends.
Apple Inc: Apple issued dividend payouts regularly to its shareholders. In their Q2 2021, they reported a cash dividend of $
22 per share, which is a form of capital dividend. Apple’s decision to issue dividends came after they amassed a large amount of cash and decided to return some of it to the shareholders.
JP Morgan Chase & Co: The company pays ongoing capital dividends to its shareholders. In 2021, JP Morgan announced a 7% increase in quarterly dividends amidst solid Q2 earnings – from 90 cents to 1 dollar per share. This is another example of capital dividends where the shareholders are earning returns from the company’s success and growth.
FAQs for Capital Dividend
What is a Capital Dividend?
A capital dividend, also known as a return of capital, is a payment made by a company to its shareholders from its pool of tax-free capital. This is generally drawn from the company’s earnings which are not subjected to taxes, typically resulting from the sale of a capital asset where there was a capital gain.
How is a Capital Dividend different from regular dividends?
A regular dividend typically comes from the company’s profits or retained earnings that are taxed both at the corporate level and the shareholder level. However, a capital dividend is tax-free at the corporate level as it is paid out of the company’s tax-free account, specifically, its “Capital Dividend Account”. Hence, capital dividends are not taxed at the shareholder level as well.
Who gets a Capital Dividend?
A capital dividend is generally issued to all shareholders of the company. The amount received by each shareholder is usually proportional to their shareholding in the company.
What are the advantages of Capital Dividends?
Since a capital dividend is paid from the tax-free capital, they provide an efficient way for companies to distribute income to shareholders without any tax implications. It reduces double taxation and leaves more of the company’s profit in the hands of the shareholders.
Why might a company choose to pay a Capital Dividend?
A company may choose to pay a capital dividend for various reasons. One of the main reasons is to utilise the balance in the Capital Dividend Account. It can also be a tax-efficient way of returning money to shareholders, and also a tool to attract investors by providing them with tax-free income.
Related Entrepreneurship Terms
- Capital Gain: This refers to the increase in value of an asset or investment above its purchase price.
- Dividend Distribution: This is the disbursement of a portion of a company’s earnings to its shareholders.
- Retained Earnings: These are profits that a company chooses to reinvest in its operations rather than distribute as dividends.
- Equity Capital: This is funds received by a business in exchange for shares of ownership in the company.
- Shareholder Equity: This refers to a company’s total assets minus its total liabilities. It represents the net worth of a company.
Sources for More Information
- Investopedia – A comprehensive website that provides thorough explanations on various financial and investment terms, including Capital Dividend.
- Accounting Tools – A helpful site that offers exhaustive articles and resources on various accounting and financial concepts.
- Corporate Tax Act Canada – A website that focuses primarily on Canadian tax rules, which can be useful when researching country-specific financial terms such as Capital Dividend.
- MarketWatch – An online finance platform that provides real-time financial news, analysis and stock market data.
