Companies controlled by perhaps the two richest men in the world, namely Bill Gates and Warren Buffett, had never declared any dividends to shareholders, despite the huge profitability and cash surpluses.
While Mr Buffett's Berkshire Hathaway sticks to this tradition, Mr Gates' Microsoft recently declared its first ever dividend.
The whole subject of the rationality of declaring and taxing dividends has recently been attracting attention afresh, primarily because Mr Bush has proposed the abolition of tax on dividend income as far as the beneficiary of the dividend is concerned.
Nearer home, the Kelkar Committee proposals on taxation have a similar provision. In fact, we in India have seen a number of changes on the issue in recent years.
Traditionally, dividend income beyond certain limits had been taxable in India.
A few years ago, it was made free of tax and a short time later, in yet another change, a tax was imposed on the companies declaring the dividends which, however, remained, for a while, tax free in the hands of the recipient.
This too did not last for very long and we are now back to square one -- unless the Finance Minister accepts the Kelkar Committee recommendations on the subject in the Budget due later this month.
Whatever the zigs and zags on the subject, evidence however is that we seem to be changing policy on the issue in an ad hoc fashion, responding to different lobbies and temporary circumstances (like the UTI's problems a few years back), rather than having a principled approach.
The case for the dividend income to be tax free in the hands of the recipient rests on the argument of double taxation of the income -- after all, dividend is disbursed out of a company's after tax profits.
So why should its payment be made subject to further taxation either by the company declaring the dividend, or by the shareholder?
In fact, internationally, the US is only one of four OECD countries which tax the dividend income of the recipients fully. All other OECD countries offer some relief or other.
For example, in the UK, income tax at the standard rate (i.e. the lowest slab tax rate) is deemed to have been paid -- thus only the relatively better off, subject to higher taxation slabs, pay tax on the dividend at the difference between the slab rate and the basic rate.
Germany, it seems, considers only half the dividend income as taxable, while Japan and Sweden do tax dividend income but at a much lower rate than other income.
Quite apart from the issue of taxation, there are other interesting facets to the subject of dividends.
Firstly, the thin line between dividend income and capital gains was recently exemplified in India when many mutual funds gave the option to investors of getting dividend or 'bonus units' in the fund.
This stratagem was adopted when the dividend income once again became taxable. The attraction is that gains in NAV or bonus units are not taxable until encashed, and that too at a lower rate provided the investment has been held for at least a year.
Secondly, in the case of companies, the owners (or investors) are rewarded in two ways -- through dividends and a rise in the price of the share.
The capital asset pricing model argues that the fair value of equity in a company is the present value of the future dividend income and the terminal value -- this fair value is not affected by whether a company declares a dividend or not as, to the extent dividends are not declared, the company's terminal value would be higher.
It is perhaps this logic that has persuaded Mr Gates and Mr Buffett not to declare dividends. Despite Mr Gates' recent defection, many other IT companies have stuck to the policy of no dividend on the argument that they need resources for growth.
Indeed, but for tax issues, in a logical world, dividend declaration or lack of it, should make no difference to returns to the investor.
Again, there is no difference between dividend declaration, and not declaring a dividend but using the same money to buy back shares in the market, if the price is attractive.
Whatever the long-term logic of dividend declaration, in the short-term, there are differences between dividends and capital appreciation, in terms of shareholder returns.
One reward, namely dividends, is in the control of the board/management, while the other, namely the price of the share, is very much subject to market sentiment and vicissitudes.
Therefore, dividend declaration as the principal source of reward to owners, would force managements to focus on profitability and cash flow than on the share price -- emphasis on the latter has led to many corporate malpractices, particularly in the United States.
Making dividend income tax free could well accelerate this change in emphasis.
There is another angle to the subject, which depends on the cash position of the company. Does it make sense to declare dividends when the company is a net borrower?
On the other hand, should not cash-rich companies declare hefty dividends rather than holding cash for which there is no immediate or foreseeable deployment in the business?
For, in that case, conservative companies would be investing the cash surpluses in riskless securities fetching a low return.
This, in fact, dilutes the return on equity and hence earnings per share.
It makes more sense for such companies to declare hefty dividends and return money not needed for the business, to the owners, also eliminating the temptations of imprudent investments.
(The situation envisaged in this argument is of course far different than the one in which Government of India as the owner has demanded hefty dividends from PSUs even if this affects their growth prospects.)
The average shareholder too often suffers from irrationality -- he would be quite happy to spend a dividend of Rs 10,000 to go on a holiday but, in case the company has not declared a dividend despite the same profit after tax, is most unlikely to sell some shares to generate Rs10,000 to finance his holiday.
Were markets rational, the two would be identical in terms of their financial impact as the price of the share would be higher to the extent dividend has not been declared.
Carrying the example further, consider that a shareholder has taken the second option and sold shares to go on a holiday.
On coming back, he finds that the price of the share has shot up -- and is full of remorse for having sold his shares. This would hardly be the case if the company had declared dividend, and he had spent it.
And yet, logically and rationally, he should be equally full of remorse -- had he reinvested the dividend income instead of going on a holiday, he would have gained handsomely from the subsequent rise in the price of the share!
The example once again emphasises the very thin dividing line between dividend and capital gains -- and yet, there is so much of irrationality about the subject in the minds of company boards/managements, shareholders, and the tax authorities.
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