Scrip Dividend

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.

• 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.

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 expenditure, 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 notes to the shareholders. They create notes payable on which interest will be included or not.

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 directors will propose a scrip dividend.
• A shareholder will approve the proposed dividend in the annual general meeting. Then only it can be given to shareholders. In AGM, 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 date 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 shares 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 dividend 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:

Solution:

Calculation of scrip dividend can be done as follows:

• No. of shares held at the record date of Dividends = 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 investment.
• Shareholders can increase their shareholding without incurring any extra transaction costs.
• It will increase the company’s total share capital.
• Shareholders can take the tax advantage 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 flow 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 share and share price will decrease after the scrip dividend issue.

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:-

• Is Dividend an Expense?
• Types of Dividend Policy
• Formula of Dividend
• Dividend Types