Utilities good on paper?

Many investors are being offered a cash or scrip dividend. Clifford German weighs the choice standfirsty

THE DIVIDEND season for privatised utilities is in full flow, bringing a spate of offers to small shareholders of opportunities to take more shares instead of a cash dividend. Shareholders in Thames Water, for example, have until 8 August to decide whether to accept an invitation to take a scrip dividend, that is to receive extra shares instead of the final dividend of 17.1p a share after tax. Shareholders who do not return the forms in time will continue to receive dividends in cash as usual.

On this occasion the scrip dividend is looking attractive. The effective cost of the new shares is 479.2p each, which was the average market price of Thames Water shares on the five business days beginning on 12 June, the day the dividend was announced.

The arithmetic for small shareholders is as follows: on a typical shareholding of, say, 260 shares, the final dividend of 17.1p a share net of tax is worth pounds 44.46p. The price of the new shares was fixed by the company at 479.2p, so the shareholder is entitled to nine whole shares worth pounds 43.13, plus a balance of pounds 1.33, which will be held over and added to the interim dividend to be paid in six months.

The current market price of Thames Water shares has been oscillating wildly with the ebb and flow of takeover rumours, and was as high as 533p last week, so the nine shares will be worth around pounds 47 and the scrip dividend is looking attractive.

It is not always the right choice, of course. The market value of shares could have fallen below 479p in the period between the announcement of the terms of the scrip alternative and the last date for making the choice. But the eight-week lag gives shareholders a valuab breathing space to see which way the market is moving before they have to choose.

Companies also like scrip dividends, because they act as a mini-rights issue, increasing the share issue by a few per cent a year, and retain the value of the dividend in the company. They also pay no advance corporation tax (ACT) on dividends taken in the form of shares.

There are no extra costs and no broker's charges to pay on shares received as a scrip dividend, something which can be attractive to shareholders who want to build their holdings up over time. But for the majority of small shareholders, a scrip dividend involves requesting, receiving, and storing an extra certificate, and, in due course, surrendering it when the shares are sold, which for a handful of shares may be more trouble than it is worth.

Shareholders can save themselves the bother of making a choice each time by putting an X in the box opting to receive a scrip dividend automatically. But once done that can only be revoked by writing to the registrars. In the meantime, the shareholder will lose the right to choose the cash dividend if the share values fall rather than rise after the dividend announcement, and the scrip offer looks expensive.

There are also tax implications. Standard-rate taxpayers are not liable to tax on their scrip, since the price of the scrip shares allotted is taken out of the net dividend, and that has already been taxed at the lower rate of 20 per cent. But shareholders who are not liable to pay income tax at all, for example because they have too little alternative income, may only reclaim lower-rate tax on cash dividends. They are not entitled to reclaim tax on their scrip dividends.

Shareholders who have shares in a PEP are not liable to tax on their cash dividends, but are not entitled to reclaim tax if they take scrip dividends instead. Top-rate taxpayers who take scrip dividends are also liable to pay a further 20 per cent tax on the full cash value of the dividends, just as if they had received cash instead of shares.