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Dividend Stripping

Overview

Dividend stripping is the process of buying shares just before a dividend is paid and selling off the shares in question after the payment when the shares go back to normal (ex-dividend). Dividend stripping is done in two ways; by an ordinary investor as a strategy of investment or as tax avoidance by company owners.

Generally, dividend stripping as a financial instrument improves risk sharing; this is because the investors who really want the high returns from the unstable prices will purchase the price strip, while on the other hand those who tend to be conservative can purchase the dividend strips. Further, dividend stripping is equally capable of enhancing information enlightening.

This is because the price and dividend strips act as an indicator of distant future resale worth of the stock, and investor’s prospects about near future dividend payoff. It is therefore right to say that dividend striping, in addition to savings in transaction costs and risk-sharing, it also provides a perfect way of unraveling the information entrenched in stock prices.

Dividend stripping – Investors

Dividend stripping in regard to an ordinary investor provides income from the dividends and a capital loss when the shares value fall. This is very normal when shares go ex-dividend. Thus, dividend stripping may be lucrative on an investor if the income is more than the loss. It can also be profitable if the tax treatment of both the income and the loss gives an advantage.

This is to say that there are different tax situations applicable to different investors which are a determinant factor to the end result. If a tax advantage applicable to all investors is applied, the results will be evident in the ex-dividend price fall. If on the other hand a tax advantage is available to a particular set of investors, the results might not end up showing in the ex-dividend price fall.

In whatever applicable case, the resulting profit on such transactions is normally very minimal, therefore it may not be valuable to the investors following the deduction of the brokerage fees, the spread of the market, risk of keeping shares overnight, or probable spillage in the marketplace be short of liquidity.

In other circumstances in different countries such as Australia, under the dividend amputation system, there are credits which can be used by eligible investors only. This tends to create worry amongst investors for the total amount shares ought to fall when going ex-dividend. Although the difference is never much, a sensibly priced drop in the shares for a particular group is a trading chance for the other group.

Dividend Stripping – Tax Avoidance

Dividend stripping as used as tax avoidance is whereby a company or an association distributes company proceeds to its owners as a capital sum in place of distributing as dividends. This is in light to the assumption that taxation on capital gains is less or may be subjected to less taxation as compared to dividend taxation. Tax treatment in such a case varies from country to country.

For instance Company A wishes to distribute $Y, with the assistance of a stripper called B. B will buy the shares of company A from its present owners at a price of $Y+Z. Company A pays a dividend of $Y to B, and B sells its shares from A back to the owners for $Z.

Thus the owners net effect is a $Y capital gain, the stripper company B gains nothing since the dividend it receives is it’s income, and a loss in share trading is a inference. Thus, B ought to be in the share trading business to receive such a deduction.

Tags: credit, deduction, Income, liquidity, market, price, risk, tax, Taxation, trading

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