Introduction

As an investor, you've likely heard about special or extra dividends; these terms are fascinating when a company goes ahead with these payouts. These payments can significantly boost your portfolio, yet they have some legal quirks that you will need to understand. This article provides an overview of the meaning of special dividends, looks at the disadvantages, and provides an example to help you understand what a special dividend is in India.

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What Is a Special Dividend?

Imagine you're the company owner through shares, and one day it announces a substantive payout that is above and beyond the regular dividends. That is an extra or special dividend, when the company announces a one-time payment to shareholders, typically induced by some extraordinary business event, "one-time distribution". In India, a company can issue a special dividend when it:

• If they earn extraordinary profits, a tech company receives a significant contract.

• If they sell off a business unit, for example, a conglomerate sells off a subsidiary.

• If they have excess cash on their balance sheet, do not expect to reinvest it shortly.

Unlike typical dividends, which you can expect at regular intervals (quarterly, annually), exceptional dividend stocks infrequently make these one-time supplemental dividends. For example, concerning its previously mentioned business, the company may announce that it will pay a special dividend of ₹50 per share when it sells land and its usual dividend of ₹10. In India, special dividends have been taxed like dividends since April 2020 and become taxable to taxpayers based on their income slab, i.e., 10% to 30% plus surcharge and cess. If the total dividend exceeds ₹5,000 in a financial year, then tax (TDS) at the rate of 10% is deducted by the company, which may allow you to adjust it against your tax liability.

Why companies offer Special dividends

You could ask, why not reinvest the surplus cash? Typically, a special dividend indicates the following:

• Financial Strength: The company does not require cash for operations or growth.

• Shareholder Reward: The issuer wants to share some of the profit with you, which signifies that you should invest in the company.

• Strategic: The company may be going through some restructuring (of divesting its non-core assets).

However, the declaration could go either way. It may indicate a promotion of income investing for income-earning investors; it may also suggest that the company has already exhausted reasonable prospects of growth, in which case, it is returning the cash, which is hugely concerning for growth investors like you.

Disadvantages of Special Dividends

Consider these disadvantages before you run off in search of exceptional dividend stocks:

1. Falling stock price: Because a company distributes a special dividend, the cash it uses to pay the dividend will be removed from the cash position and valuation. Typically, the stock price will fall by the special dividend amount on the ex-date. If you owned 100 shares for ₹1,000 a share and the company paid a special dividend of ₹100 per share, it would fall to ₹900 on the ex-date. So, if you did not eventually sell and were only waiting for the special dividend, you have offset your payout, unless the stock price rises from a ₹900 price.

2. Additional tax hit: Special dividends will increase your taxable income in India. For example, you received a ₹1 lakh special dividend. If you are taxed at 30%, now you have a ₹30,000 hit (plus cess) on additional taxable income, which will net you less than a purely capital gain that could have waited longer with a future tax hit. There will not be an additional tax on capital gains way.

3. Future special dividend payouts: Special dividend payments are not always a promise or commitment. Also, if you rely on them to pay your bills for a month or two, you will be greatly disappointed if they do not repeat, and now the money you were planning on is not there. This does not cater to the uncertainty in your financial planning.

4. Opportunity Cost: A company distributing a large one-time extra dividend may acknowledge that no high-return investment choices are available. How you view your investment may indicate a slower increase in the value of your holdings compared to companies reinvesting their profits into innovation or physical capacity.

5. Market Misinterpretation: Some companies attempt to cover operational challenges through special dividends, hoping that a flashy one-time payment or dividend will distract from declining profit margins, rising debt or other operational issues, tempting an investor into a value trap.

Example: Vedanta Special Dividend

So, what is a special dividend in India? Look at Vedanta Ltd., a top mining and metals corporation in India. In FY22, Vedanta declared several special dividends, including a special dividend of ₹31.5 per share declared in June 2021, totalling over ₹11,000 crore. These special dividend payments were funded by robust cash flows from selling commodities at very high prices and selling assets, most notably its stake in a zinc business.

Owning 1,000 Vedanta shares resulted in you receiving a pleasant windfall of ₹31,500. While Vedanta's share price dropped after being 'ex', it was anticipated as it reflected cash leaving the company. Naturally, commenters would focus on the slip in share price, and investors would ultimately cheer the payout, while some criticised Vedanta's mountainous debt level and reliance on highly volatile commodity market prices. The special dividend provided a cash payout and renewed income, while also evoking questions about any growth capability in the future.

Conclusion

Investment platforms such as BSE or NSE will post company announcements, listen to company reports, and plan your business investments accordingly. Remember to utilise the additional dividends carefully and look at your overall income and capital growth horizon. A special dividend can be considered the icing on your cake, rather than the cake itself.

Special dividends can be profitable, but caution should also be applied. You must realise what they mean, consider their disadvantages, and look at some examples before you can make an informed decision in India's growing investment landscape.