You could improve your return by selling the share instead of waiting for the dividend payout—but there are caveats.
I was recently asked an interesting question about dividends. The person concerned was curious as to whether—from a tax and return perspective—it is better to take the dividend itself, or sell the share and take the profit prior to the dividend payout. It is therefore important to understand how the declaration and subsequent payment of a dividend impact the share price, all else being equal.
The easiest way to explain how this works is through a real-life example—that of thermal coal producer Thungela Resources Ltd (JSE code: TGA). On 15 August 2022, Thungela announced that it was declaring the payment of a dividend of R60 per share. In the same announcement, it stated that the last day for trading to qualify to receive the dividend was 20 September 2022. The share would then trade ‘ex-dividend’ from 21 September 2022 onwards. In simple terms, this means that if you were a registered shareholder at the close of business on 20 September 2022, you would be entitled to receive the dividend.
However, if you sold the share before this cut-off time, you would not receive the dividend. Likewise, if you only bought the share on or after 21 September 2022, you would not receive the dividend. In market terms, during the period between the date of declaring the dividend (15 August 2022) and the last date upon which a shareholder would be entitled to receive it (20 September 2022), the share is regarded as being ‘cum-dividend’. From 21 September 2022, the share then becomes ‘ex-dividend’, because those who bought it on or after that date would not be entitled to receive it.
Given this background, what impact would you expect these events to have on the share price? Let’s look at the sequence of events, assuming that Thungela was trading at R280 per share immediately before the announcement:
As soon as the announcement was made, anyone buying into this share would receive the dividend, provided that they kept the share until the close of business on 20 September 2022. At the same time, any shareholder wanting to sell their shares after the announcement but before the close of business on 20 September 2022 would forfeit their right to receive the dividend. It thus stands to reason that a buyer would be willing to pay more for a share that is now ‘cum-dividend’ while the seller would seek to be compensated for having given up their right to such dividend.
Assuming a reasonably efficient market and sufficient trading volume in this particular share, one would expect the share price to increase to R340 (the previous trading price of R280 plus the dividend of R60). Once the share goes ‘ex-dividend’ on 21 September 2022, the seller would have already received the dividend and the buyer would thus not be entitled to it. All else being equal, the share price should therefore drop back to R280. If we look at the chart of Thungela on Page 7, we note that the share was trading at R285.29 immediately prior to the announcement, had reached R380.97 by 20 September 2022 and dropped to R318.29 the next day. Allowing for some market sentiment, it is clear that the share price moved exactly as expected.
This is where the tax question comes in:
To keep the numbers simple, assuming that the shareholder had bought their share just before the announcement at R280, kept the share past the cut-off date of 20 September 2022, and received the R60 dividend, the company would have withheld R12 in Dividend Withholding Tax (DWT). This means that the shareholder would now be holding a share worth R280 and be entitled to receive cash of R48. The combined value of the two would thus be R328, giving them a gain of 17.14% in five weeks (or 178.29% annualised). Now suppose that the shareholder decided that instead of waiting for the dividend to pay out, they would sell the share once it reached R340, what then would be their net gain? The simple answer would be R60, given that no tax is withheld at the source. However, the gain will most certainly be taxed…but at what rate?
The ‘capital vs revenue’ conundrum:
How SARS determines whether a particular receipt is of a capital or a revenue nature has been covered fairly extensively in a previous issue of Tax Breaks (Render unto Caesar, Issue 443—December 2022), and is thus beyond the scope of this particular article. However, the tax treatment differs based on whether the share sold is considered to be part of one’s investment portfolio (capital) or one’s trading portfolio (revenue). In both cases, the taxpayer’s marginal rate of tax also comes into play.
If the sale is treated as capital, then the capital gain is determined by subtracting the ‘base cost’ (for simplicity’s sake, this would be the cost price of the share) from the sale proceeds. In this example, the capital gain is R60 (R340 – R280). 40% of this gain is included in the taxpayer’s income and taxed at their marginal tax rate. Depending on their other taxable income, their marginal tax rate could range between 18% and 45%, making the effective rate of Capital Gains Tax (CGT) somewhere between 7.2% and 18%. This means that tax-wise, the taxpayer is better off selling their share than receiving the dividend, regardless of their marginal tax rate—this is because the DWT rate is a flat 20%. What’s more, the first R40 000 of capital gains per annum is exempt from CGT—so if one’s total capital gains for the year do not exceed R40 000, the entire gain will be completely tax-free!
The picture is somewhat less rosy if the taxpayer is selling this share out of their trading portfolio, as any gain made would be treated as revenue. Assuming the same R60 gain as per our example, the tax thereon would be between 18% and 45%. This means that the taxpayer would be better off selling the share only if their average rate of tax (the actual tax rate based on the tax paid as a percentage of taxable income) is below 20%. Above 20%, and the taxpayer is better off receiving the dividend since there is no further tax payable on dividends once the DWT has been deducted.
Of course, the above example is extremely simplistic—deliberately so, in order to explain the principles more clearly. However, real life seldom imitates textbooks—and there are a number of factors that need to be taken into account:
The unpredictability of dividend announcements:
Unless an investor or trader has inside information (which is what is referred to as ‘insider trading’ and is, of course illegal), no one can predict exactly when a company is going to declare a dividend. With the JSE being a relatively liquid market, and given the immediacy of information thanks to modern technology, timing a purchase in order to gain maximum advantage from the declaration of a dividend is extremely difficult. Even if you are glued to your screens, chances are that once a dividend has been declared, by the time you’ve got your ‘buy’ order in, the value of the dividend will probably already be factored into the share price.
The unpredictability of markets:
In the example of Thungela, the share price is closely linked to international movements in the price of thermal coal. This price, in turn, depends on the supply and demand for energy. With gas supplies, in particular, being curtailed due to Russia’s invasion of Ukraine, and demand being dependent on how severe the Northern Hemisphere winter turns out to be, trying to predict energy prices (and their impact on the price of thermal coal) means being a meteorologist (to predict the weather) or a mind-reader (to work out what’s going on in Vladimir Putin’s head). Given such volatility, market sentiment is even more fickle at the moment than it normally is—and, to paraphrase the late Harry Oppenheimer, the share prices may go up or down, and not necessarily in this order. The reality is borne out by the experience of the person who asked the original question. On the day the dividend was declared, Thungela was trading at R285.29 per share. The price was expected to reach around R345 once the dividend announcement had been made but actually topped out at R380.97—having overshot expectations by around R36 per share.
Once the share went ‘ex-dividend’, the price dropped to R318.29 (i.e. a fall of R62.68) … and then bounced along until falling below the original R285.29 on 11 October 2022. The roller-coaster ride continued, with the share bouncing back to around the R310 mark a couple of times before plummeting to R234.80 a month later. It then rallied all the way back to R323.19 on 1 December 2022 before the bottom fell out of it, reaching a low of R218.47 on 26 January 2023 (the time of writing).
The takeaway? While tax certainly is a factor when it comes to the buying and selling of shares (or any asset, for that matter), the question was put to me with the clear benefit of hindsight. Whether the person asking the question would have been able to predict the trajectory of Thungela’s share price in advance with sufficient accuracy to be able to even make the right decision as to when to exit the share, is debatable. I, for one, have my doubts. Therefore, the best advice that I can offer is that you adopt the trading or investment strategy that best suits your goals, temperament, and risk tolerance—and then engage a good tax practitioner to help you deal with the tax consequences of your chosen strategy.
WRITTEN BY Steven Jones
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)