Ask Harry: What’s the difference between a dividend and a distribution?
People often tell me that they find investing intimidating because of all the technical language involved in becoming a competent investor.
Thankfully, for the most part you can be blissfully ignorant of 99% of the technical terms in finance and still beat the majority of professional investors out there.
I’d go so far as to say that keeping things uncomplicated is the key skill you need to develop if you’re going to get ahead financially.
That said, there are a few terms you really do need to familiarise yourself with on your journey to financial security. Two of the more confusing are dividends and distributions. Often these terms are used interchangeably, even though they have very different meanings.
A dividend is a payment made by a company to a class of shareholders out of profits earned, or from its retained earnings. While there can be many different classes of shares, the two most common ones are ordinary shares and preference shares.
The amount paid out as dividends to ordinary shareholders is determined by the paying company’s board at its discretion.
Some companies aim to pay a set percentage of their net profit after tax to ordinary shareholders, while others try to keep their dividends per share relatively constant irrespective of fluctuating profitability. Either way, as an ordinary shareholder you have no say in how much you will receive in dividends for each share you hold.
For preference shareholders the amount of dividends received will depend on the terms of preference class, but in general preference shareholders are entitled to receive dividends before ordinary shareholders (hence the ‘preference’).
Most listed companies tend to declare and pay dividends twice a year, once as an interim dividend and a second as the final one.
Depending on the source of the company’s profits and how it’s been taxed, dividends paid by Australian resident companies can be partially or fully ‘franked’, so that a tax benefit is received by Australian tax resident shareholders known as an imputation credit. These credits can be highly valuable to certain types of investors, particularly those on lower rates of tax.
Dividend imputation is a complex area of taxation, and if you’re not familiar with how it operates we’d strongly encourage you to read the ATO material on this topic, or to consult with a suitably qualified taxation professional.
Distributions are most commonly associated with trusts, a type of structure where legal ownership of trust assets reside with a Trustee, but those assets are held for the benefit of one or more other parties (beneficiaries).
Trusts have been around for hundreds of years, and are a common alternative to forming a company. They are used extensively in the investing world, with managed funds being a form of trust where units are issued to investors in proportion to their share of ownership in the pool of trust assets.
The vast majority of Exchange-Traded Funds operate as trusts, the difference being their units are listed on an exchange and are thus tradeable like company shares. Superannuation is another common form of trust used for investing purposes.
When it comes to managed funds and ETFs, the Trustee is responsible for managing the assets of the trust, for collecting trust income and for administering, accounting for and paying out trust income to unitholders. These amounts are known as distributions.
Trusts must generally distribute the income they receive to their unitholders in full each financial year or face penalty rates of tax on undistributed trust income. So at the end of each financial year you should receive a tax distribution statement outlining the amounts and types of income you’ve earned as a member of the trust.
The income might be in the form of dividends received by the Trust from shares it holds on your behalf, interest from cash and fixed interest investments, lease payments from properties held, or even distributions from investments in other trusts.
As a general rule most trusts will provide their year end tax statements to unitholders within 6–8 weeks of the end of the financial year. Most provide some guidance on the various types, and amounts, of income that investors have to transcribe into their tax returns.
As with dividends, if you are unsure about how to read or understand your annual trust distribution tax statement, you should seek advice from a suitably qualified taxation professional.
Clover portfolios are designed using Exchange Traded Funds (ETFs) carefully selected for low management fees and high diversification. Learn more about our investment strategy.
Who is Harry?
Harry has over 20 years of experience in wealth management. In that time he has advised both individual and institutional investors. Previously a Certified Financial Planner, he now is a Certified Investment Management Analyst. So.. he knows his stuff.
When not making personal finance easier and less intimidating for Aussies, Harry loves his weekend bike rides and spending time with his wife and son. He’s pretty much the finance-savvy uncle you never had.
The above has been provided for general information purposes only, and does not purport to be financial or taxation advice. You therefore should not rely on this information in making any decision in relation to investing, and instead should consider seeking independent taxation or other advice to determine how this information relates to your unique circumstances.
Originally published at Clover Blog.