By Molly Cyrus 
Introduction
Dividend taxation can be said to be a substantial factor in financial operations since it affects decisions made by corporations and the ways investors act. Dividends in particular constitute a major source of earnings especially for those who invest independently since they rely more on the returns on their investment for their sustenance as is the case with retired individuals
However the taxation of dividends brings some difficulties and one has to be very careful in choosing the right strategy. As we have noted earlier governments employ dividend taxation as a means of generating revenue considering its implications for investment and economic growth. This guide is designed to give a clear understanding of dividend taxation with the principles underlying it its historical development the international approach and the impacts it has on investors as well as corporations.
We will also consider controversies concerning dividend taxation and its social and economic impacts as well as come up with a conclusion that will summarise these facts.
Understanding Dividends
Dividends are payments made by a corporation to its shareholders especially from profits earned by the company. These payments can take various forms
Cash Dividends
This is the most common form of payment in which a firm pays out some of its profits in cash to its stakeholders.
Stock Dividends
Other than cash a company may redistribute its shares to its shareholders by offering more of them.
Property Dividends
These are the distributions other than cash or stock which are comparatively less common.
Special Dividends
Occupy time payments that are made to the shareholders and most often are made as a result of extraordinary nonrecurring activities like the sale of a business division. This income can seem like a steady stream from an investors perspective yet the taxation of this income can differ greatly from jurisdiction to jurisdiction.
The principle of dividend taxation can therefore be outlined in the following manner such as Dividend taxation is governed by a few key principles which vary by country but generally include
Double Taxation
All the aspects of dividend taxation the most widely debated is the question of double taxation. Companies are taxed based on their income and when these incomes are distributed as dividends to stock holders the recipients bear other taxes personally. This results in a situation where the same income receives double taxation one at the corporate level and the second at the personal level.
Qualified vs Ordinary Dividends
In most countries dividends are categorised into two namely the qualified dividends and the ordinary dividends. Ordinary dividends are however subject to normal tax rates while qualified dividends are generally taxed at a preferential rate close to that of capital gains tax as a form of encouragement for long term investment.
On the other hand ordinary dividends are another type of dividends that attract the usual income tax. There are conditions to be fulfilled for the dividend to be charged at the preferential rate such as it should be from a U.S. Company or a QFC and the investor has to hold the stock for a given time. Withholding Tax Particularly the governments of different countries tax on the amount of dividends to be paid to investors of other countries.
The corporation pays a portion of the dividend less tax before distributing it to the foreign investor such an amount can be offset against the investors tax amount payable in their home country depending on the agreed treaty.
Evolution of Dividend Taxation
What is more the experience of dividend taxation is typical for more general shifts in tax policies and overall philosophies that marked this or that period. In the first instance dividends are like all other kinds of income with regard to taxation. However as governments saw the possibility of losing these revenues through taxing investment income at rates that were detrimental to overall economic growth many proved reforms.
The Early Years
Historically at the beginning of the 1900s dividend taxes were charged in ways similar to wages and salaries in almost all jurisdictions. That high level of taxation when utilising corporate income tax regularly contributed to the total effective tax rates of more than 50% preventing investments in dividend paying companies.
Mid20th Century Reforms
Most of the developed states made efforts to alter the mechanism of double taxation in the middle of the 20th century. For instance The U.K. started an imputation system whereby the shareholder could claim a credit on the taxes that the corporation had paid. Other countries such as the U. S therefore reintroduced lower rates on dividend income me realizing that high taxes and dividends could act as a bias.
Recent Trends
Over the past decades many countries have attempted or have changed from lowering the rates of dividend taxes to making these taxes similar to capital gains taxes. This was seen in a shift of emphasis towards encouraging investment and acknowledging the fact that taxes on dividends are burdensome and can have detrimental effects on the economy including discouraging entities from issuing dividends to shareholders.
Dividend Taxation An International Analysis
The taxation of dividends cannot be well explained for a particular country because it is a policy that all governments have developed to come up with solutions in accordance with their current tax policies their fiscal and economic plans and the legal systems of a particular country.
United States
In the United States dividend taxation is divided into two main categories qualified and ordinary dividends. Qualified dividends are taxed at lesser long term capital gains rates that reach between 0% and 20 % based on the total income of the taxpayer. There are two kinds of dividends ordinary and qualified. The former are taxed at the individual’s ordinary income tax rate which ranges from 10% to 37%.
With respect to dividends from U.S. companies that are paid to foreign investors a withholding tax of 30 per cent is applicable subject to a reduction in line with treaty provisions. The foreign tax credit also benefits U.S. citizens and residents whereby they can utilise it to offset their own taxes in the U.S. in regards to holding taxes paid in a foreign country on dividends.
United Kingdom
The U.K. however is on a different level with regard to the taxation of dividends. Since the elimination of the imputation system in 1999 dividends paid to the residents of the United Kingdom are adjusted with a dividend tax. There is however a tax free dividend allowance under which investors are free to receive a certain amount of dividends without incurring any tax. Anything above this means that the dividend is taxed at 8%.
In this case therefore the tax imposed on the share amount is reasonable and should not pose a considerable burden on the shareholders. 75% 33. 75% or 39 that is 35% on average but the rate can vary depending on how much the taxpayer earns.
The U.K. also has withholding taxes on dividends so that a foreign investor may be taxed at this rate but the amount varies depending on double taxation treaties.
Canada
Use of Dividend Tax Credits
Canada has formulated a method that helps shield the twin taxation problem. Dividends that Canadian companies receive are recoverable at the investors marginal tax rate but through the tax credit the taxation of dividends is much preferable to regular income taxation.
Canada also levies withholding taxes on dividends to non residents which stands at 25%. However this can be negotiated lower by signing a tax treaty.
Australia
Australia uses what is referred to as the franking credits where any dividend that the companies pay is usually accompanied by franking credits that show how much tax has been paid at the company level. These credits help shareholders reduce the tax on the dividend income they receive thus eliminating the issue of double taxation. Some of the economic implications of dividend taxation are
The taxation of dividends has far reaching microeconomic implications for investors and macroeconomic implications at the economic level. Appreciation of these effects is important to policymakers investors and corporate entities.
Effects of Growth and Development
The dividend taxes can affect the investors in a very particular way. Higher taxes on dividends decrease the amount of cash that shareholders can get after tax hence decreasing the net dividend to investment.
Giving paying stocks a rather unfavourable image compared to other forms of investments such as bonds or growth stocks which do not use dividends. Hence firms feel pressured to either cut or eliminate dividends and instead offer share repurchases or reinvestment of profits.
To investors the dividend tax credit has a great impact on determining strategic investment strategies to adopt. When the income received from the dividend is taxed at a higher rate as compared to capital gains tax then investors can prefer to invest in GroWorth Stocks which offer the investors most of their return from an increase in the price of stock rather than dividend earnings. Such preference results in wider shifts in market peculiarities including higher capital investments in non earning companies.
Effect on Corporate Behaviour
Another aspect of dividends that affects corporate decision making is the taxation of dividends. There are a number of ways in which profits can be given to shareholders such as by issuing dividends or retaining them for reinvestment. High taxes on dividend income may lead to a reduction in the frequency or amount of dividends that a company pays out in a bid to reduce taxes paid while satisfying the investors demands for cash returns on their investment through other means.
For instance in the U. S corporate share repurchases have featured prominently in the last few years as a means of distribution to investors instead of dividends partly because they enable the shareholders to make capital gains at a preferable rate for capital gains tax. This has raised concerns about whether companies are making decisions out of tax purposes for the benefit of the shareholders or for the long term growth of the business.
Consequence of Economic Development
The impact of dividend taxation on the economy is an area that has many controversies among economists. Most have argued that high dividend taxes imply a reduction in capital formation hence slowing down the overall economic growth rate. In this vantage the low taxation on dividends is perceived as a way of enhancing saving and investment as well as encouraging innovation and fostering employment.
Some other people believe that dividend taxation has little impact on economic growth overall. They claim that taxation of dividend income is justified because dividend income is largely received by upper income earners who do not have the propensity to change either consumption or investment in response to changes in taxation rates. In this view lowering the taxes on dividends is likely to favour principally high earners while posing little return to the entire economy.
Debates Surrounding Dividend Taxation
As a subject of taxation dividends have caused many controversies over the years explaining the different economic virtues and policy objectives. Some of the key points of contention include
Equity and Fairness
As stated above the current taxation policy has incorporated equity or fairness as a central tenet. With regard to higher dividend taxation equity has been advanced as one of the major reasons. Dividends are one form of investment returns that have been seen to favour the rich most of the time. It is also argued that by imposing high tax rates on dividends the government can fine high income individuals for extra dollars prevent the income gap between the rich and the poor and provide a source for public goods and services.
Various people have criticised this as being wrong because the taxes are levied on the investors particularly older adults and others rely on dividends for income. They argue that taxation of corporate profits twice over through the two systems is wrong and will skew investment patterns to the detriment of the economy’s welfare.
Capital gains relative to Dividend taxation
Another important discussion is the comparison of the taxation of dividends and capital gains. With reference to Figure 2 it is clear that in many jurisdictions dividends which are also a type of return on investment are taxed at a higher rate than capital gains taxes. It also generates a tax differential that benefits stocks whose companies release new shares provide share buybacks and affirm growth shares rather than those companies that declare dividend yielding stocks.
Certain public policymakers have mooted the idea of integrating the taxation of dividends and capital gains in a bid to eliminate this distortion and thus improve the investment environment.
Others have defended the provision of preferential rates to capital gains with the idea that such a strategy motivates long run investments and risk bearing which are important for economic growth. According to this view it is only right that dividends should attract higher taxation than the overall capital appreciation of the stocks.
Economic Efficiency in Contrast to Revenues
Another good example of a policy mix that always seeks to have optimum resource allocation efficiency and mobilise enough resources for government use is the taxation of dividends. First cutting dividend rates is beneficial to the level of investment savings and the pace of economic growth. Another case is dividends which are still considered to be a severe source of earnings for many governments.
The reduction of taxes on this income may lead to situations when certain deficits appear in the budget and no more money can be allocated for public services. Thus policymakers are in a dilemma when formulating dividend tax policies to accommodate all these priorities. In some instances governments have had to look for a compromise as in some countries where qualified dividends have been tagged as preferred treatment with special tax rates in order to ensure that such dividends are subjected to tax but not at the ordinary income level.
Taxation of Dividends
Individual investors must learn how the taxation system of dividends operates so that they can plan their financial affairs better. Some key considerations include
DRIP design and its Wisdom
Almost every company has what is called a Dividend Reinvestment Plan or DRIP which enables shareholders to use their dividends to purchase more shares in the company without necessarily going through a broker and being charged commissions. However what one must not forget when it comes to using DRIPs for compounding its returns is that every single dividend received and reinvested is still taxable in the year of receipt even though the actual cash was not collected.
Tax Advantaged Accounts
In most countries dividendpaying stocks can be held in tax sheltered structures for instance in the USA in an IRA (Individual Retirement Account) or the U.K. in an ISA (Individual Savings Account) therefore the dividends received in these structures are taxed or tax free depending on the type of the structure. Applying it to these accounts reduces an investors dividend tax risk and increases their aftertax returns.
International Tax Considerations
For investors who have bought stocks in foreign companies there are international tax implications. Most countries have imposed withholding taxes on foreign investors receiving their dividends and the rates of tax may differ depending on the investors country and any treaties that exist. It should however be noted that in some circumstances the investor can offset the withholding tax against his home tax liability through the tax credit method but there are a lot of complexities involved in the process.
Policy Changes and Future Direction
Governmental policies on dividend taxation change with time depending on the prevailing economic factors political pressure and developments in tax theory. Some potential future trends in dividend taxation include
Correlation of the Corporate
There is one approach to eliminate the problem of double taxation and it is the integration of the corporate and individual taxation systems. This is where the concept of integrating the corporate profits tax with a single locking in rate would come into the framework this would mean that the corporate profits would only prompt a tax at either the corporate or individual level but not both.
Some countries are already adopting this process such as Australia with its franking credits system while there may be pressure on other jurisdictions to adopt this method.
Environmental and Social Criteria
Also with the rising trend in the use of sustainable investing there may be growing pressure on the dividend taxation policies to adopt ESG analysis. For instance the government can create policies involving issuing tax credits for the dividend payment of firms that have met some sustainability standards or increase taxes on the dividends of firms in the negative impact industries such as those involved in fossil fuel extraction.
Digital Dividend and Cryptocurrencies
Since digital assets and cryptocurrencies are on the rise then the idea of the dividend is also shifting. Some blockchain projects have dividend or reward structures where token holders are paid depending on the project’s performance or the number of ongoing transactions. The authorities are not yet quite sure as to how to qualify these novel kinds of income and more discussions and sensitive alterations can be considered in the following years.
Conclusion
The taxation of dividends is a massive and intricate procedure that defines the relations between investors corporations shareholders and the whole economy. It is an important source of money for governments but at the same time it is a rich source that affects investment patterns managerial decisions and economic development.
Where high taxes on dividends are applied there is a need to consider the effects of the policy on the national economy including the effects of discouraging investors from divesting or encouraging debt financing as opposed to equity financing. The controversies related to dividend taxation fairness its effects on the efficiency of the economy and the comparison of the taxation of gain derived from both the stock and sale of stock divide society on the underlying belief about taxation.