A policy of paying out almost all profits in dividends tends to stifle capital growth in the share as the company has little retained earnings and less capital available for financing growth and acquisitions. On the other hand the profit of the dividend itself is the reward to shareholders. This argument has been going on for years in academic circles and tends to settle on the conclusion that dividend policy is essentially irrelevant to shareholder returns.

The market, however, sees things differently. Dividend policy is very important to many shareholders, and a steady, reliable and gradually increasing dividend is taken by the market to mean the company itself is steady, reliable and growing. Companies that announce a reduction in the dividend without a satisfactory reason (which might involve cashing up for acquisitions) are frequently mauled by the market. Even companies that announce a shrinking profit may not suffer greatly if at the same time they announce that the dividend will remain unchanged or greater than last year. A steady dividend is valued by the market as a show of confidence by management that profits are secure in the long term. An announcement of a dividend cut is often a sign that management has lost confidence in a rapid recovery or further expansion, and is taking emergency measures to ensure its own longevity. Skittish investors will bail out when such an announcement is made taking their money elsewhere.

Dividends are usually sent out as a cheque, however some companies can make arrangements to deposit the amount directly in your account. Be sure to notify the company of your tax file number so that withholding tax is not levied.

In 1996 the Australian Financial Review examined 103 leading companies and reported on the time it takes them to pay out a dividend. Naturally it is in a company's best interests to hold on to the money as long as possible, so it should not be surprising that many can wait a very long time before sending out the money. The most prompt payers, sending cheques 83 days after the end of the financial year were Challenge Bank, Coal and Allied Industries, North Flinders Mines and Mt Leyshon Gold Mines. The slowest were AAPC, Santos, Sons of Gwalia and Harvey Norman, taking 177, 167, 165 and 157 days respectively to get around to getting that cheque into the mail.

Until 1987 dividends were taxed twice. A company would pay tax at the company rate and then send out dividends from the after-tax profits, which once received by the shareholder would then be taxed as income at the individual's highest marginal tax rate. In 1987 a concession was made to attribute (impute) tax already paid by the company as a credit to shareholders, and dividend imputation allowed shareholders to discount tax bills by the amount already paid on their behalf by the company they own shares in.

A dividend on which the tax has been fully paid at the company rate is known as a fully franked dividend, and attached to the dividend is a franking credit, redeemable on the shareholder's own tax return as a credit for tax already paid. As well as fully franked dividends, other companies pay only a portion of the company tax rate due to a variety of special deductions available to some companies, and will issue partially franked dividends or unfranked dividends, in which case there is only partial imputation or zero imputation. A franked percentage is sometimes quoted, if the company only pays half the company tax rate then the dividend is said to be 50 percent franked.

Franking credits are redeemable against the taxpayer's other income, if the taxpayer is on a marginal tax rate below the company rate then the franking credit will be redeemable for a partial refund on the tax bill, so the difference will be attributed to the taxpayer such that only the marginal tax rate is paid. However if the taxpayer has a higher rate of tax than the company rate, some tax will still need to be paid, and the franking credit will be redeemable as a credit toward the tax bill, with the balance still owing to the tax office.

The calculation is simple, the franking credit is applied on the final tax bill. The tax is tallied in the usual way and finally the franking credit is subtracted from the last line of the tax calculation as an amount already paid on your behalf. No further discounts are available. In addition, franking credits are only applicable toward other income. If your sole income source is franked dividends, you pay the company tax rate, or higher (if your marginal tax rate is above the company rate). Franking credits are not refundable in cash. Legislation has just passed (New Business Tax System (Miscellaneous) Bill 1999) that now enables individuals to claim an imputation credit without having to set this against other income, so that excess credits can be redeemed for a refund, very useful if franked dividends are your only form of income, as now you only pay a maximum of your own marginal rate.

The holding period rule states that ordinary shares must be held for a period of at least 45 days, and preference shares for 90 days - not counting the day of acquisition or disposal during the 'qualification period', to be eligible for franking credits. The qualification period begins on the day after you acquire the shares and ends on the 45th (or 90th) day after which the shares or interest in the shares become 'ex-dividend'. The holding rule applies for all who's franked dividends exceed the threshold of $2000 in the period 13 May 1997 to 30 June 1999. From 1 July 1999 the relevant threshold becomes $5000, under proposed legislation introduced into Parliament as the New Business Tax System (Miscellaneous) Bill (No. 2) 2000. Watch the ATO web site for updates on this law.

A small shareholder exemption applies for an individual who receives franked dividends less than the threshold amount ($2000 or $5000). If the franked dividend is less than this amount the holding period rule does not apply, for amounts above the threshold, franking credits are applicable on the amount below the threshold but not the amount above it. Franking credits in excess of the threshold are void.

Different rules apply for foreign nationals, so if applicable make certain to read the tax office guide 'You and Your Shares'.

Dividend ReInvestment Plans (DRIPs or DRPs) are arrangements where companies pay out dividends in the form of new issued stock rather than cash. DRIPs are a form of cheap capital for the company, rather than pay up in cash they just print out a few new share certificates and use them in lieu of cash. Companies usually continue to do this as long as they need the capital to finance expansion or amortise debt, whereas they cancel the DRIP when this need passes.

There is a good reason for companies to not wish to continue with the DRIP. Institutions place pressure on them to cancel such a policy as it leads to a dilution of the earnings per share (EPS). Like a government that tries to solve its monetary shortfalls by turning to the printing press a form of inflation sets in and new issues of stock tend to destroy shareholder value as much as they create it. An issue of new shares that increases the total number of shares on offer by 5% thus causes a dilution of EPS by 5% and will precipitate a fall by that amount. The only benefit to shareholders is that a steady dividend paid on the increased number of shares will lead to larger dividend payments overall. This is a weak argument though, as the company could give the same benefit to shareholders by simply increasing the dividend without diluting the EPS, and the larger dividend will likely lead to greater capital gains to boot.

Nevertheless, DRIPs remain very popular with small shareholders who have their eyes on the small (around 5%) discount offered on DRIP shares, and they usually kick up a big fuss when DRIP schemes are cancelled. DRIPs also have the advantage that the share purchase is free of brokerage and stamp duty.

As far as the Tax Office is concerned, DRIPs are the same as any dividend payment, they are regarded as a payment in kind and taxed for their full monetary value, though franking credits can still apply. In Australia there is no real tax advantage in DRIPs, unlike some other nations where the shares are genuine freebies and can be highly advantageous from a taxation point of view.

A variation on a DRIP is an issue of bonus shares. The bonus shares are issued from the company share premium account and are not treated like a cash dividend, but are added to holdings and treated as having been acquired at the same time as the original purchase of the underlying shares, and capital gains tax levied accordingly at the time of sale. If you purchased a number of lots of shares over a period of time, you will need to track which bonus shares belong to which purchase and your capital gains liability will be calculated accordingly when you sell, remembering the ATO "last in last out" principle which states that the first shares you sell are regarded for CGT purposes as the most recent you bought.

Financial advisors do not generally endorse DRIPs for a number of reasons. The few percent you save on the market price has to be weighed against a number of different considerations. First there is the dilution of EPS. Secondly, a DRIP forces you to invest only in that company. Your spending discretion is taken away as the company nominates itself as the only company you may spend your dividend on. Thirdly is the delay in the dividend payout. Remembering that a DRIP exists only so a company can make an extra buck, it is likely that the shareholder will be disadvantaged when the company is left with the decision as to the optimal time to sell you its stock. It will inevitably choose a moment when the stocks are riding high so as to give away as few shares as possible, the company has a window of anything up to 6 months to decide when it wants to issue the new DRIP shares. For these reasons investment advisors suggest taking a dividend in cash, rather than participate in a DRIP. For those compulsive types that know they will spend the dividend on non-investment related things, a DRIP can force them to reinvest the dividends, and hence can't be all bad for those types of people.

Some non-cash dividends such as payments in kind are regarded by the ATO as identical to cash payments. If a private company pays out in product or property, certain discounts or otherwise, the ATO may regard this as taxable income and levy tax.

The idea has been around for a while to apply this logic toward shareholder discount plans and other shareholder incentives, including such measures as the Coles-Myer Shareholder Discount Card. Do not be surprised if some time sooner or later such schemes start to attract taxes such as either income tax or Fringe Benefit Taxes. At any rate it can be argued that shareholder discounts are not free, they take away profits from the company you own. Woolworths has stated that it will never introduce a scheme like the Coles-Myer one because the loss of profits would lead to reductions in dividends and capital gains on their stock, in their opinion this would be worse than not getting a small discount on your groceries.