Tax treatment of Dividend Reinvestment Plans v Cash Dividends for Share Investors

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Thursday, 16 August 2018

Michelle Maynard, Partner at Carbon Accountants and Business Consultants, discusses the tax implications of Dividend Reinvestment Plans (DRPs) and Cash Dividends for Share Investors. The biggest issue she sees with her clients who choose DRPs, is that the shareholder is assessed on the income, which might incur a tax liability without receiving any cash to cover this cost. 

Michelle Maynard Updated

Dividends: Are Dividend Reinvestment Plans treated differently to cash dividends?

When investing in shares, you may have the option to have the dividend paid as shares in the Company rather than cash. These are called Dividend Reinvestment Plans (DRPs). In today’s article we explore DRPs and how they affect your tax.

A dividend, whether paid in cash or shares, is assessable income in the year it was paid or credited to you. This date is shown on your dividend statement. Dividends can be franked – this means tax has been paid by the company and the shareholder can claim this credit back. Alternatively, the dividend may be unfranked – this means that no tax has been paid and therefore cannot be claimed.

The assessable nature of the dividend and the claiming of any franking credit does not change whether the dividend is paid in cash or shares.

So what are the pros and cons of DRPs?

Pros Cons
There is no brokerage charged on the acquisition of these shares Each time investors acquire shares through DRPs, they establish a cost base to track. Over time, their holding might be including several separately acquired parcels – tracking this can create administrative issues.  
   
It allows investors to grow their shareholding in a company with no cash outlay When the shares are sold, the accounting for the capital gain will be more detailed, which could incur additional compliance costs.
   
DRPs often come at a discount to the market price The shareholder is assessed on the income which could incur a tax liability without receiving any cash to cover this cost. 
   

The last point under the “con” list is the biggest issue we see with our clients. With small DRP it might not create much of an issue but let’s further explore it with large investments.

Jenny is an investor who has a large shareholding (144,000 shares) in an ASX listed company – Carbon Ltd. The shares are currently worth $8 each. In March 2018 the company declared a fully franked dividend (at 30%) of 25c per share.

Jenny has the option of taking the $36,000 dividend as cash (144,000 x 25 cents) or can receive 4,500 additional shares in the company (36,000 / 8)

Jenny decides to participate in dividend reinvestment plan and received 4500 new shares on 14 April 2018. She includes the dividend of $36,000 in her 2017-2018 assessable income.

For CGT purposes, she acquired 4500 new shares for $36,000 on 14 April 2018.

But what are the consequences of the above and what would the difference be if Jenny took the cash option? For this example, let’s assume Jenny earns $100,000 per year.

  Cash Dividend DRP
Salary 100,000 100,000
Dividend 36,000 36,000
Franking Credit 15,428 15,428
Taxable Income 151,428 151,428
     
Tax & Medicare Levy 46,688.92 46,688.92
PAYGW by employer (26,632) (26,632)
Franking Credit (15,428) (15,428)
Amount payable $4,628.92 $4,628.92
     

As you can see in the above example, Jenny will need to find $4,628.92 to cover a tax liability no matter which option she takes. The difference is under the cash dividend option, she will have $36,000 deposited into her account that she can use to cover this shortfall. If she has chosen the DRP, she would not have this cash to meet this obligation. If Jenny was to sell the shares she acquired to meet this tax obligation, she may be subject to CGT if the shares had increased in value.

When deciding whether to participate in a DRP there are many factors that need to be considered.

Michelle  partnered with Carbon in 2017, bringing a wealth of experience in accounting and bookkeeping. Her extended suite of services covers everything from tax accounting, planning and estimates, to cloud integration, payroll and SMSF. Michelle started her career as a cadet in the Australian Taxation Office, then as a graduate at PwC. 

Before joining Carbon, she was a manager at PKF, bringing a wealth of knowledge and experience to the team at Carbon. Michelle specialises in providing tax and accounting advice to SMEs and HNWIs and their family groups, working to achieve the most effective strategies for them, both financially, tax effectively, and to help achieve their desired lifestyle. Contact Michelle at Michelle.m@carbongroup.com.au You can also connect with Carbon Accountants and Business Consultants via Facebook,  Twitter and LinkedIn. 

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