What are Non-Dividend Distributions?

Dividends

Distribution can mean a number of things when it comes to financial matters. However, it tends to refer to some kind of payment from either a fund, an account, or a security to either an investor or some other kind of investment. For example, when someone receives a bond coupon, that can be considered a kind of distribution. Likewise, when someone receives a sum from a retirement account, that can be considered a kind of distribution as well. As such, distribution is a term that covers a wide range of occurrences, thus making context very important for understanding what has happened, what is happening, and what will happen.

What You Should Know

For shareholders, one of the most common distributions would be dividends. After all, a lot of corporations choose to pay out their extra cash rather than reinvest it into their revenue-earning operations, which can be motivated by a wide range of considerations under a wide range of circumstances. For instance, there are some corporations that choose to pay out dividends on a regular basis, so much so that their dividend announcements are as regular as clockwork movements. In some cases, this is because they have matured with the result that they no longer have a lot of good opportunities for further growth, thus making reinvesting extra cash into their revenue-earning operations less important. In other cases, this is because they have an unusual business model that offers them exceptional stability at the cost of either no or next-to-no opportunities for growth. On top of this, there are some corporations that are just so well-run that they have been able to pay dividends on a regular basis for years and years or even decades and decades, which is a remarkable feat to say the least.

Of course, there are also corporations that pay dividends on a much more irregular basis. Perhaps unsurprisingly, they can be motivated by a much wider range of considerations for their choices. One excellent example would be corporate executives seeking to build up some shareholder loyalty, which is useful for convincing said individuals to hold on to their shares for longer periods of time. That might sound rather strange, but it can be very important because that enables corporate executives to pursue more long-term strategies rather than focus on the maximization of short-term profits at the expense of everything else. Another excellent example would be the corporations that wind up with an unexpected sum of cash on their hands at a time when they don’t have any better use for it than to pay it out as dividends, which can happen because of everything from the sale of a segment to a successful lawsuit. Regardless, there are many other potential considerations for these irregular dividends, thus making examining the context something that has to be carried out again and again for a complete understanding.

Non-dividend distributions exist in this context. Like their name says, they are payments that corporations make to shareholders that are not dividends, meaning that they represent a share in the capital rather than a share in the earnings. As such, non-dividend distributions are not treated in the same way as dividends.

Why Would a Corporation Issue Non-Dividend Distributions?

Non-dividend distributions can happen for a number of reasons. One, a corporation might choose to issue a stock dividend. Generally speaking, dividends are paid out using cash. However, corporations can choose to pay them out using other assets instead. Stock shares are the next most popular choice. They aren’t quite as convenient as cash and cash equivalents, but they are still a great deal more convenient than, say, land, buildings, and other long-term assets. Two, a corporation might choose to perform a stock split, which is when each of its existing shares is split into a number of shares. This has a huge impact on the stock share price because the total ownership of the corporation is now split up into more shares, meaning that each one is now worth less on the stock market. As such, corporations tend to perform stock splits because they want to change their share price into something lower. Some people might find that to be very strange because the common desire is to see share prices rise higher and higher.

However, it is worth mentioning that higher and higher share prices remove more and more investors from the pool of potential buyers, thus slowing down the rate at which transactions for said shares happen. Due to this, corporations sometimes want to reduce their share price for the purpose of restoring a measure of their liquidity, which can be very useful for them, their current shareholders, and their potential shareholders. Three, a corporation might issue a payment to its shareholders in the event of either its liquidation or the liquidation of one of its segments. This tends to be a rather rare occurrence. After all, most corporations liquidate because they have become so unprofitable that their revenue-earning operations are no longer sustainable. Unfortunately for the shareholders, there is an order of precedence for who gets paid from the corporation’s assets. First, secured creditors get to collect whatever it was used to secure the credit in the first place. Second, unsecured creditors get paid out of whatever remains, which is notable because unsecured creditors encompass a very wide range of parties. For instance, both employees who haven’t been paid and governments that are still owed taxes count among this category. Third, shareholders get paid from whatever remains after that because their status as owners means that they take on more of the risk. Since illiquidity means that it is difficult for a fast sale to produce the full value of long-term assets, this means that shareholders are lucky if they manage to get anything out of the process.

What Are Some Important Things to Keep in Mind about Non-Dividend Distributions?

Non-dividend distributions are sometimes called non-taxable. However, this is rather misleading because they aren’t really non-taxable. Instead, the recipients don’t get taxed until the associated shares have been sold. Be warned that different countries can have very different policies for how this kind of thing is taxed. As a result, interested individuals should do what they always do when they run into a tax question, which should be contacting a tax specialist as soon as possible for further inquiries. In this as in other things, expertise and experience matter a lot for the eventual outcome.

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