assignment of right to receive dividends

45. Assignment of right to dividend

Can a shareholder's dividend be paid to a third party?

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Dividends – do all shareholders get them.

Profits made by limited by shares companies are often distributed to their members (shareholders) in the form of cash dividend payments. Dividends are issued to all members whose shares provide dividend rights, which most do.

This division of company profits in proportion to the number of shares held by each member also referred to as ‘distributions’, is often described in terms of:

• Dividend rate – the actual amount that is paid out in respect of each share (e.g. £1)
• Dividend yield – the dividend rate paid out per share, expressed as a percentage of the current stock value (e.g. if the dividend rate was £1 but the market value of each share is £50, then the dividend yield is 2%)

Dividend payments do not always comprise the entire profit of an organisation. Many companies will decide to re-invest a portion of their profit in the business. This is known as ‘retained earnings’.

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Companies cannot count dividends as business expenses when calculating Corporation Tax.

Furthermore, they are not allowed to pay out any more in dividends than is available from profits already accumulated and eligible for this purpose. These available profits are known as ‘distributable reserves’ or ‘distributable profits’.

What is the procedure for paying dividends?

Broadly speaking, there are two forms of dividends: final dividends and interim dividends. Below we will consider the general rules that apply to the payment of both types of dividends, as well as make the distinction between interim and final dividends.

General rules

Company directors should hold a board meeting and agree to ‘declare’ a dividend (either themselves or subject to approval by the members). Minutes of the meeting must be kept, even in the case of a sole director.

A dividend ‘voucher’ must be created for each dividend payment, and the following information should appear on the voucher:

• Date of dividend payment
• Amount of the dividend
• Name of company
• Names of shareholders eligible to receive a portion of the dividend payment

A copy of this dividend voucher must be provided to each shareholder eligible to receive a portion of the dividend, and a further copy should be retained for company records.

The rules for issuing and paying dividends can vary from company to company. Any specific company procedures should be stated in the articles of association.

A free dividend voucher template is available from 1st Formations.

Final dividends

Final dividends are issued on the basis of profits for the fiscal year.

Directors will make a recommendation as to the amount of dividend, but they must seek approval from the members at a general meeting or via a written resolution. At this point, the shareholders can decide to reduce the level of dividend payment, but they cannot declare a higher amount.

Once a final dividend payment has been declared/approved, the company is obliged to pay this.

Interim dividends

Interim dividends can be paid out at any time during the course of the financial year.

Subject to any restrictions in the articles of association, this form of dividend can be declared by directors without any need to gain approval from shareholders.

Any decision to pay an interim dividend must be on the basis of relevant interim accounts which should be filed with Companies House.

If an interim dividend has been declared by the directors alone, there is no obligation to actually pay it. The board can change its decision if circumstances change.

What are the duties of directors when declaring dividends?

As per section 174 of the Companies Act 2006 , a company director “ must exercise reasonable care, skill and diligence ” and, in accordance with s 172, “ must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole ”.

When deciding whether to recommend a dividend payment, directors need to have regard to these duties, and others contained in the relevant part of the Companies Act 2006 .

As such, they should first ensure they fully understand the rules surrounding dividend payments and carefully assess the financial position of the company to determine whether the level of dividend payments is appropriate.

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Not only must dividend payments fall within the limits of available distributable reserves, but they should also take into account the overall position of the company to meet its debts. Directors who authorise dividend payments for which there are insufficient distributable profits* are personally liable for any consequent shortfalls.

They can also be held liable if a dividend is paid when the company is insolvent or if they should have reasonably foreseen cash flow problems.

* Section 830 of the Companies Act 2006 states that: “ A company may only make a distribution out of profits available for the purpose ” which consists of “ its accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital duly made. ”

Technical guidance on distributable profits under the Companies Act is available from the Institute of Chartered Accountants in England and Wales (ICAEW).

How are dividends paid?

Dividends were traditionally paid via cheque, but now it is more common for payments to be made using direct bank transfer – although there will normally be a choice for the shareholders. The methods of payment available will generally be stipulated in the articles of association.

Sometimes dividends will be paid in the form of additional shares. This is known as a scrip dividend. Often there will be an option for members to receive a dividend either in the form of cash or additional shares.

One of the benefits of opting for a scrip dividend is that transaction costs (i.e. purchasing new shares) can be avoided. However, there is no tax advantage because scrip dividends are treated in the same way as cash dividends for purposes of taxation.

Dividend payments have a tax-free allowance of £1,000 (applicable to the 2023/24 tax year). After this, they are taxed according to the shareholder’s income tax band: 8.75% at the basic rate; 33.75% at the higher rate; and 39.35% at the additional rate. GOV.UK provides more information about tax on dividends and the latest rates.

It is worth mentioning that some companies also offer dividend reinvestment plans (DRIPs) that provide members with more shares instead of cash. However, there are some important technical differences between drip and scrip dividends .

Multiple classes of shares and dividends

Some companies offer different classes of shares for the purpose of organising a specific distribution of dividend payments. For example:

• Ordinary shares – these may be separated into alphabet classes, each assigned a letter to differentiate them (e.g. “A” ordinary shares, “B” ordinary shares etc) – a different dividend rate can then be applied to each of these classes of alphabet shares.
• Preference shares – these have a fixed rate of dividend which is paid out before the other share classes, meaning that they take precedence over ordinary share dividends. Any remaining sums available for distribution are shared between the holders of ordinary shares after preference shareholders have been paid.
• Cumulative preference shares – these are similar to preference shares, but they provide that, if a dividend payment is missed or not paid in full (e.g. as a result of insufficient distributable profits), the shareholder will receive any shortfall in a future dividend payment when there are sufficient distributable reserves.
• Deferred ordinary shares – holders of these types of shares will not receive any dividend payment until holders of the other shares have received a minimum dividend, after which they will receive the same rate of dividend as other shareholders.
• Non-dividend paying shares – there may be instances where a specific class of share that excludes its holders from entitlement to any dividend payments is required.

Any decision to create new classes of shares to distinguish dividend rights should be approved at a board meeting with an ordinary resolution. Minutes of the meeting should reflect the approval and be filed accordingly.

The articles of association should also be amended if necessary (e.g. if they do not permit the creation of new classes of shares).

Dividend waivers

There are occasions when a shareholder may choose to not accept a dividend payment; this is known as a dividend waiver.

The reason for waiving a dividend may be because it is preferable to keep money in the company and re-invest this in running the business, compared to receiving payment and losing some of the profit through the consequent taxation of dividends, etc.

A Deed of Waiver should be used to give effect to a dividend waiver. In the case of final dividends, the waiver should be put in place prior to the dividend being declared; in the case of interim dividends, the waiver should be set up before payment.

Author:  1st Formations

John Carpenter is Chief of Staff at 1st Formations. He is in charge of ensuring all departments meet their targets to allow us to provide all of our customers with an exceptional level of service. Outside of work, John spends time with his wife, young son and cat. He enjoys reading history books and going to rock gigs.

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I have a percentage of shares in a limited company that have typically been paid by a. monthly dividend payment on profit earned after corporation tax is deducted this has been the case for 10+ years.

I have now been told by the company’s owner and main shareholder that he is going to withhold dividend payment’s even though the company is making a profit.

I own shares in the business, Is this correct?

Thank you for your kind enquiry.

As a general rule, there’s no strict requirement that profit has to be paid to the shareholders of the company. Oftentimes, profit might be kept within the company, for example for the purposes of reinvesting in the company’s operations. This is called retained earnings. Further, it should be noted that it is for the directors to determine whether a company can declare a dividend (after all, they are normally liable, if the company pays a dividend it should not have). So, in a strict sense it is not incorrect to say that company might decide not to pay a dividend, although this is of course subject to the articles of association, and any shareholder agreements in place, etc.

We trust this information is of use to you.

Kind regards, The 1st Formations Team

I have just been paid an interim dividend. However it was close to six weeks after the announcement, and five weeks after the first person received their payment. Some were paid by cheque and some by BACS but this was done over a period of five weeks, ie we were not all paid at the same time you may or may not be able to help me but thanks for taking the time to read this J DAVIES

Thank you for your kind enquiry, John.

Generally speaking, shareholders may have a preference as to how they receive their dividends, so it’s not uncommon for some shareholders to receive payment in one form and other to receive payment in another. For example, the model articles of association state that any dividend must be paid by a bank transfer, cheque, or another means as agreed by the directors (or a combination of any of these).

As regards the timescales of the payment, we are not aware of a specific timetable in which companies must pay their dividends. However, we would expect shareholders to be paid at the same time. It is not usually possible to vary the payment terms between shareholders unless a share structure is put in place that permits this variability – for example, multiple share classes.

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How dividends can increase options assignment risk

Most experienced investors are familiar with the adage that "if an investment opportunity sound too good to be true, it probably is." While this sentiment may often be associated with overly optimistic assumptions, it also applies to investors who sell options contracts without first considering the ex-dividend date for a stock or ETF.

How dividends work

A quick review of how dividends work: A dividend represents a payment of a company's revenues to shareholders, most often in the form of cash. Cash dividends are paid out on a per-share basis. For example, if you own 100 shares of a stock that pays a $0.50 quarterly dividend, you will receive $50.

Not all companies pay dividends, but if you're investing in options contracts for companies that do pay them, you need to keep several important dates in mind:

• Declaration date: Date on which a company announces the per-share amount of its next dividend.
• Record date: The cut-off date established by the company to determine which shareholders of its stock are eligible to receive a distribution. This is usually, but not always, 1 day after the ex-dividend date.
• Ex-Dividend date: Date on which a stock's price adjusts downward to reflect its next dividend payment. For example, if a stock pays a $0.50 dividend, the stock price will drop by a half point prior to trading on the ex-dividend date. If you buy a stock on or after the ex-dividend date, you are not entitled to the next dividend.
• Dividend (payment) date: Date shareholders receive cash in their account from a dividend.

See Locating dividend information for stocks for additional details.

Dividends offer an effective way to earn income from your equity investments. However, call option holders are not entitled to regular quarterly dividends, regardless of when they purchase their options. And, unlike stock or ETF prices, options contract prices are not adjusted downward on ex-dividend dates.

This can cause a problem for anyone who has sold an options contract without first considering the impact of dividends. Why? Because the risk of being assigned on an option contract is higher when the underlying security of an in-the-money option starts trading ex-dividend. To understand the risks and how dividends impact options contracts, let's explore some potential scenarios.

Avoiding or managing early assignment on covered calls

As noted above, the ex-dividend date is particularly important to anyone who writes a covered or uncovered call option. If a covered call option you have sold is in the money and the dividend exceeds the remaining time value of the option, there is a good chance an owner of those calls will exercise his options early.

If you are assigned, you must deliver your shares of the underlying security, as well as the dividend income, to the owner of the call. Let's examine a hypothetical example to illustrate how this works.

• Bob owns 500 shares of ABC stock, which pays a quarterly $0.50 dividend.
• The stock is trading around $25 a share on August 1 when Bob decides to sell 5 October 30 calls.
• By early October, ABC stock has risen to $31 and, as a result, Bob's covered calls are in the money by $1. The calls will expire in 10 days and tomorrow the stock will start trading ex-dividend.
• Because the remaining time value of the call option is less than the value of the dividends, the call owner will likely exercise his options on the day before the ex-dividend date.

See Locating option values in Active Trader Pro ® .

If Bob does not take any action to close his covered call position, there is a good chance he will be assigned on the ex-dividend date. This means he will no longer own 500 shares of the stock and he will not receive the dividend income.

To avoid this scenario, Bob has a couple of choices:

• He could buy back the calls he sold to retain the stock and the dividend. However, he would have to do this prior to the ex-dividend date. If he waits until the ex-dividend date or later, he will not be entitled to the dividend income. Keep in mind that it's possible to get assigned prior to the day before the ex-dividend date, so this strategy is not foolproof.
• The other option is to close out his short position and write a new covered call with a later expiration date or a higher strike price. This strategy is known as "rolling" your options contract forward.

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Avoiding or managing early assignment on calls not covered by shares

Now let's consider what could happen if Bob had sold uncovered calls on ABC stock:

• As in the example above, ABC stock pays a quarterly $0.50 dividend and is trading around $25 a share
• Bob has a negative view on the stock and decides to sell 5 uncovered October 30 calls
• By early October, ABC stock has risen to $31 and, as a result, his uncovered calls are in the money by $1

To make matters worse, Bob learns that tomorrow the stock will start trading ex-dividend. Because the remaining time value of the options is less than the value of the dividends, owners of these calls will likely exercise their options 1 day prior to the ex-dividend date.

To limit his exposure, Bob has several choices. He can buy back his uncovered calls at a loss, buy the stock to capture the dividend, or sit tight and hope to not be assigned. If his calls are assigned, however, he will have to pay the $250 in dividend income, in addition to covering the cost of delivering 500 shares of ABC stock. If Bob had initiated an option spread (buying and selling an equal number of options of the same class on the same underlying security but with different strike prices or expiration dates), he could also consider exercising his long option position to capture the dividend.

Other considerations and risks

If you are implementing a spread strategy that includes long contracts and short contracts, you need to remain particularly vigilant in regard to assignment risk. If both contracts are in the money and you are assigned on the short contracts, you will not be notified until the following business day. While you can exercise your long position on the ex-dividend date to eliminate the short stock position that was created, you will still owe the dividend because you were short the stock prior to the ex-dividend date.

Ways to avoid the risk of early assignment

If you are selling options (covered or uncovered), there is always the risk of being assigned if your trade moves against you. This risk is higher if the underlying security involved pays a dividend. However, there are ways to reduce the likelihood of being assigned early. These include:

• Do your homework: Know if the stock or ETF pays a dividend and when it will start trading ex-dividend
• Avoid selling options on dividend-paying stocks or ETFs when your trade includes ex-dividend
• Invest in European-style options: American-style options can be assigned at any time before the option expires, European-style options can only be exercised at expiration

See Locating dividend information for ETFs for details.

If you are a Fidelity customer and you have questions about your exposure to assignment risk, you can always contact a Fidelity representative for help.

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