Impact of Dividend Tax on Share Valuations

For many years accountants have advised owner managers to adopt a reward structure of low salary/high dividend when they are operating through a limited company.

This nostrum has had a consequent influence on the valuations when we have to value a minority interest in a company within the matrimonial and litigative sphere.

In the absence of a shareholders agreement, there is a default presumption that a rational investor will not pay very much for a minority shareholding in a private company.

This is predicated on the basis that the controlling shareholders (who will be the owner managers) will not want to pay anything to an outsider unless they have to.

Thus, if there is no shareholders agreement with a clause requiring a dividend to be declared, then the controlling shareholders will decline to declare a dividend.

With no prospect of a guaranteed income our rational investor will act logically and not want to pay anything for an asset not delivering any return, unless there are special circumstances.  These might be a potential sale in the short term or a special buyer who would want to get hold of that minority holding.

Once counter argument to this default position might be that the owner managers would still want to declare a dividend so that they can then avail themselves of the tax advantages of taking reward by way of a dividend.

This is a very decent point.  We still tend to be influenced by the thought that the rational investor cannot be sure that a dividend will be declared and hence perhaps discount the tax impact more than one might initially think.

Recent tax changes have reduced the benefit of taking reward by way of dividend.  This is the consequence of the additional levy of 7.5% on dividend income.  The palliative of a dividend allowance has now been weakened by its reduction to just £2,000.

A dividend based reward strategy still has the edge but it is far less significant.

Accordingly, it probably reinforces our instinct that the rational investor will judge that he cannot reasonably expect a dividend to be declared as a matter of course.

Thought processes will of course depend on the unique facts of each valuation.

If we can determine that the owner managers will be able to deploy other methods of reward extraction so that they do not need to resort to a dividend, we would need to factor this in.

In most cases one might conclude that the owner manager would probably want to take advantage of the £2,000 dividend allowance if they cannot utilise it elsewhere.  £2,000 to a majority shareholder probably would mean a fairly minimal dividend for a minority shareholder.  Nevertheless it will then be possible to attribute a value to the minority shareholding based on a desired rate of return.  It will assign a value to the minority shareholding but it may not be overly exciting.

If you would like to discuss this subject in more detail, do get in touch.

Post by Paul Short