National Grid (NG.) are returning some of the cash received from the sale of their stake in a gas distribution business to shareholders via a large special dividend. And some will be returned via market share buy-backs, the wisdom of which may be questionable. But the real concern for private investors is that dividends are taxed as income even though this is in essence a “return of capital”. It is not being paid out of operating profits, but simply from the sale of part of the business.
In the past, companies would recognise this fact and the tax problem faced by private investors by offering a “B” share alternative that could then be redeemed and turned into a capital gain (as capital gains are less highly taxed than income for many investors). But this was outlawed in the 2015 Finance Act – there is a good article in the Daily Telegraph today that explains this in more depth.
But consider the plight of retail investors in Electra Private Equity which is much worse. They recently announced a similar return of cash via a special dividend of 2640p per share. The share price the day before it went ex dividend was 5,110p so effectively half the value of the company is being returned as a dividend. One investor who contacted me invested £20,000 in the company many years ago, and his holding is now worth near £150,000 so he will receive an enormous income tax bill. Needless to say he is not happy.
A particularly iniquitous aspect is that a lot of the “profit” he is being taxed on actually simply results from asset price inflation over the years.
Could the company have considered alternatives? Spreading the return of more than one tax year may have helped, but another possibility would be to return the cash via a tender offer to shareholders. Those taking it would realise a capital gain, while those not doing so would see the value of their existing holding unaffected (the share price would adjust to reflect the lower asset value per share and the proportionally similar fewer number of shares in issue).
There may be other possibilities that a tax and accounting expert could advise on, but unfortunately it’s probably the impact on institutional investors that is driving this desire to pay dividends and private investors are being prejudiced.
I may raise this issue at the National Grid AGM in July, but it will be too late to affect this and dividends can be declared by a company’s directors without a vote of shareholders. Similarly on Electra Private Equity, it is too late to object as the dividend has been declared and so will be paid.
This is yet another example where the taxation of capital gains and dividends is irrational and deeply prejudicial to the interests of investors. The solution, without prejudicing the Governments need to receive tax, would be harmonisation of dividend and capital gains taxes. But the latter should be index linked to avoid taxing fictitious profits.
Roger Lawson
I agree that Capital Gains Tax operates in an iniquitous and illogical fashion. Society would benefit from a situation in which capital is allocated in a fluid fashion, according to need and merit, without tax-driven distortions or barriers to decision-making. So if I believe that, for instance, J Sainsbury no longer deserves my money but Tesco does, I should be able to make that capital allocation decision on the relative merits of the two firms alone, without triggering a tax that could deter me from switching.
Thus, the ideal system would not only reintroduce indexation and harmonise the treatment of capital gains and dividends but would also tax the former only if the capital realised was not reinvested in similar assets within a reasonable period (say 30 days).