Capital Dividend – Definition

Cite this article as:"Capital Dividend – Definition," in The Business Professor, updated January 24, 2020, last accessed June 1, 2020, https://thebusinessprofessor.com/lesson/capital-dividend-definition/.

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Capital Dividend Definition

A Capital Dividend is a dividend paid to shareholders of a corporation. The dividend funds come from the capital that was contributed to the company in exchange for an ownership interest. The funds do not come from profits or operational income.

Distributing a dividend from a shareholder’s contributed capital means that, if specific conditions are met, the dividend is not taxable. The shareholder paid taxes on the contributed capital prior to the contribution. Thus, receiving a return of that capital is not a taxable event.

A Little More on What is a Capital Dividend

The Capital Dividend Account (CDA), is a special account used by corporations for paying shareholders tax-free dividends. The Capital Dividend Account does not appear on a balance sheet. It is sometimes listed in the financial statements’ reports, but nothing more. Even if this account stays confidential, shareholders have every interest in closely following it because it gives them an extraordinary tax advantage of being able to withdraw the company’s money without paying any taxes. Hence, shareholders earn a non-tax dividend if their balance is positive.

In Canada, CDAs are typical to help companies and shareholders in separating seed capital from profits. In addition, they allow shareholders to know which taxable dividends are not taxable. A central concept of taxation principle is strictly applied by the CDA. This concept requires every person to pay a fairly equal tax irrespective of whether their income is earned directly or via a company. Dividends are typically paid at lower wages because of this principle. A capital dividend is paid from the capital dividend account of a corporation which is a Canada Revenue Agency (CRA) account that is tracked on the basis of information filed in the corporate tax return of that corporation.

Capital Dividend and Regular Dividend Payment

A dividend is the proportion of profit and profits that a company pays out to its shareholders and that earnings can be either returned or remitted to its shareholders as a dividend when the company earns profit and accumulates retained income. The distinction between a capital dividend and a conventional dividend is that a conventional dividend is usually paid out of the profits of a company. The most popular form of payment is cash dividends, and are paid in cash, usually through a transfer of electronic funds or printed paper cheque. It is the most common way in which the company’s shareholders share the corporate profits in a conventional dividend payment method.

Capital Dividend and Shareholders’ Equity

Stockholders Equity (also known as Shareholders Equity) is an account that consists of share capital plus retained earnings on a company’s balance sheet. It also reflects the residual value of assets minus liabilities. Capital dividends are usually extracted from the equity of a corporation. If all of the assets of the company were liquidated and all debts repaid, the equity of the shareholders would be the sum returned to the shareholders. It ensures that holders of bonds are compensated before holders of shares. Thus, the value of the equity beyond the general amount of capital is not of great interest to the debt holder to determine total solvency.

Reference for “Capital Dividend”

https://www.investopedia.com/terms/c/capital-dividend.as

https://investinganswers.com/financial-dictionary/…/capital-dividend-account-cda-615…

https://retirehappy.ca/capital-dividend-account/

https://www.welchllp.com/blog/capital-dividend-the-forgotten-dividend/

https://www.nbc.ca/business/advice/money…/capital-dividend-account-what-for.html

Academic Research on “Capital Dividend”

Earned/contributed capitaldividend policy, and disclosure quality: An international study, Brockman, P., & Unlu, E. (2011). Earned/contributed capital, dividend policy, and disclosure quality: An international study. Journal of Banking & Finance35(7), 1610-1625. We examine the agency cost version of the lifecycle theory of dividends by taking advantage of cross-country variations in disclosure environments. The outcome hypothesis posits that transparent disclosure environments lead to higher dividend payouts because shareholders can more accurately measure (and therefore demand) excess cash flows. In contrast, the substitute hypothesis argues that opaque disclosure environments lead to higher payouts because managers have stronger incentives to establish their reputation for fair treatment. Our empirical results confirm both hypotheses and contribute to the literature in two primary ways. First, we confirm that the lifecycle theory of dividends explains dividend payout patterns around the world. Second, and more important, we show that the firm’s disclosure environment plays a significant role in dividend payouts through its effect on agency costs; that is, we confirm an agency cost-inclusive lifecycle theory of dividends.

Sizing up new capital dividend reinvestment plans, Fredman, A. J., & Nichols, J. R. (1982). Sizing up new capital dividend reinvestment plans. California management review24(4), 77-84.

Instability in the dividend policy of the Istanbul Stock Exchange (ISE) corporations: evidence from an emerging market, Adaoglu, C. (2000). Instability in the dividend policy of the Istanbul Stock Exchange (ISE) corporations: evidence from an emerging market. Emerging Markets Review1(3), 252-270. Dividend policy behaviour of corporations operating in emerging markets is significantly different from the widely accepted dividend policy behaviour of corporations operating in developed markets. This study provides evidence from the Istanbul Stock Exchange (ISE), an emerging European stock market, and analyses empirically whether the ISE corporations follow stable cash dividend policies in a regulatory environment that imposed mandatory dividend policies. Unlike the empirical results supporting the stable dividend policy behaviour of corporations operating in developed markets, the empirical results show that the ISE corporations follow unstable cash dividend policies and the main factor that determines the amount of cash dividends is the earnings of the corporation in that year.

Investment opportunities, corporate finance, and dividend payout policy: Evidence from emerging markets, Abor, J., & Bokpin, G. A. (2010). Investment opportunities, corporate finance, and dividend payout policy: Evidence from emerging markets. Studies in Economics and Finance27(3), 180-194.

Return on Equity CapitalDividend Payout and Growth of Earnings Per Share. Murphy Jr, J. E. (1967). Return on Equity Capital, Dividend Payout and Growth of Earnings Per Share. Financial Analysts Journal23(3), 91-93.

Cost of CapitalDividend Payment and Optimal Dividend Policy——Theoretical Analysis and Empirical Interpretation, WANG, P., ZOU, Y., & XIAO, Q. (2012). Cost of Capital, Dividend Payment and Optimal Dividend Policy——Theoretical Analysis and Empirical Interpretation. Research on Economics and Management8. Inappropriate dividend policy can really be called one of stubborn diseases of China’s listed companies for a long time.Making a scientific and rational dividend policy is the responsibility and obligation of listed companies.Based on the perspective of cost of equity capital,standing on the position of the protection of shareholders’ interests,the paper theoretically proved the contents and characteristics of the optimal dividend policy from the angle of internal financial policy making.According to the listed companies’ financial data,the paper then empirically analyzed their practical dividend policies, to evaluate their scientificity and rationality.Finally,the paper made some policy suggestions on the optimal dividend policy of our listed companies.

The Role Of Cash Holdings, Working CapitalDividend Payout On Capital Investment, Chan, A. (2018). The Role Of Cash Holdings, Working Capital, Dividend Payout On Capital Investment. Journal of Applied Business Research34(3), 419. An objective of this paper is to investigate the relationship between firms’ capital investment spending, cash holdings, and working capital in an expanding Asian financial market.  A sample of publicly traded manufacturing firms on the Hong Kong Stock Exchange was examined during the period 2005-2014. The empirical results provide strong and statistically significant evidence on the effect of cash flow on investment.  Working capital also exhibits significant relationship with capital investment spending, though the relationship is not as strong and significant as that with cash flow and cash holding.  Firms with low dividend payout policy over the sample period depended heavily on cash flow, changes in cash flow and, to a lesser extent, on working capital to finance spending on fixed plant and equipment.  These results suggest that the effect of capital investment spending financed by internal cash flow on firm value may depend on a firm’s dividend payout.

Demographic Change and Capital Dividend: Inverted U Mystery of Chinese Savings Rate, Hualei, Y., Lingyun, H., & Wei, W. (2017). Demographic Change and Capital Dividend: Inverted U Mystery of Chinese Savings Rate. Studies of International Finance, (4), 3. Accompanied by a generational change, baby boom and baby bust generation successively enter into the labor market during 2000 to 2030, savings rate path show a similar inverted U path that China’s annual number of births display during 1980 to 2010, and capital bonus lag the demographic dividend. With post-95 s and 00 s baby bust generation swooping to enter the labor market in 2015-2030 years, only the improve of human capital and labor participation rate cannot change the trend character of the decline in the savings rate, savings rate trajectory showed the cliff drops characteristics, demographic dividend disappear with capital dividend gradually disappear. The disappearance of the demographic dividend will lead to the disappearance of capital dividends.Finally, this paper examines the delay retirement program the effect on the savings rate. It is found that, whether it is gradually delayed retirement, or immediate delay retirement, which cannot change the fact that the capital dividend disappeared, a downward trend of the savings rate. But the delay retirement can reduce the magnitude of the decline in the savings rate, slower capital dividends disappear, escort to achieve China’s two hundred years goal and gain time of improve the total factor productivity.

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