Special Dividends Reveal Companies’ Reactions To Tax Increase

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Tax (1) For those who think that the threat of increased regulation or taxation does not result in reactions by the private sector are proven to be wrong, as the number of publicly traded companies issuing or expediting dividend payments in the last quarter of 2012 to evade possible higher rates is ample proof.

If the Obama Administration and Congress will not take preventative action in 2013, the top effective tax rates for dividends will increase to 44.6%. As the result, about 200 firms have either moved up dividends or initiated special payments. For example, Wal-Mart (WMT) and Disney (DIS), among others, expedited the payment of dividends in the fourth quarter of 2012 that were originally scheduled for early in 2013. Also, Costco (COST), Las Vegas Sands (LVS), and many more companies  announced special dividend payments for shareholders.

Although, it might be a welcomed action by some investors, in no way can this be considered a productive use of capital, as tax considerations should never motivate an investment decision, and in the long run, it will only hurt the economy. Further, actions such as these will be much worse if greater taxes or regulations are proposed and/or implemented.

And the result?

The very loser from this will be the free market, itself. It is difficult to believe that companies such as Costco and Sturm Ruger (RGR) did not have more productive uses for capital, some of it borrowed, than giving it to shareholders. The whole purpose of buying the shares of a publicly traded company is to gain from its productive use of capital as decided by the management team.

However, in response to the 2013 tax increase, these entities have decided that the best use of the capital is to pay shareholders rather than reinvest funds to increase the value of the firm as a whole, and consequently, increase the market value of the stock. A company’s alternatives are to undertake more projects, create jobs, repurchase the company’s own shares, acquire new companies and profitable assets, and reinvest in financial assets. As the result, it is difficult to see how the shareholder, the company or the overall economy gains from this is the long run…particularly if the taxes are repealed.

Further, legislators, and regulators would do well if they remember this hurried and forced reaction to the possibility of higher taxes in 2013. For example, Apple (AAPL) has reduced its tax burden, at both the state and federal level, by operating from areas such as Nevada, Ireland, Holland, Luxembourg and the British Virgin Islands . More specifically, Apple created subsidiary entities in low-tax jurisdictions and channeled as much revenue as possible through them. It has been reported the cumulative effect of Apple’s maneuvering is that over 70% of the company’s revenue is recorded in tax-friendly overseas jurisdictions, greatly minimizing its corporate tax burden. Apple is not alone, as its complex financial, and accounting methods do not break any laws.

Perhaps allowing corporations to keep their income at lower level tax rates will allow them a more productive use of capital to improve the  American economy without issuing special dividend payments.

Regarding the effect of regulation, rather than deploying assets to facilitate the most efficient use of capital possible, companies will instead utilize scarce resources to mitigate the costs of government intervention in the free market. For example, financial industry i struggling to cope  with increased costs of compliance, and legal departments to address audits by government agencies, and expensive settlements to avoid further lengthy litigation.

Also for financial companies, more onerous regulations or increased revenue measures would force firms in the financial sector to modify operations or move to more hospitable areas. The ability of financial firms to operate on a global basis allows them to move their operations overseas. There are plenty of examples of  financial companies successful operations from Bermuda or the Bahamas for no other reason than a more hospitable tax environment (all regulations are a tax). As the result, it would certainly not be in the best interests of the United States, because besides losing jobs, the United States will lose tax revenue.

As for investors, individuals need to pay close attention to their investment decisions, and adjust their personal portfolios to reflect their own preferences. Investors might be surprised that the stock they purchased with certain goals in mind might produce unintended income. No dividend payout is more favorable for investors, because taxation on a dividend income is higher than on a capital gain.

Instead, investors should invest for the long term based on the fundamentals of the company, and ignore the short term rise after the media announcements. The turmoil from the Fiscal Cliff allows investors even more opportunities to pick up great companies at a discount due to the short term volatility in the market. Income investors should focus on those companies that have a history of raising their dividends regularly.

As is clearly being demonstrated now, tax dollars are being lost, and poor business decisions being made due to the higher taxes on dividend payments in 2013. Greater regulator, and tax burdens for the private sector will only result in even more negative actions for all parties concerned. There is a lesson to be learned by all.

Anna Timone (195 Posts)

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