Difference Between Dividend and Long-Term Capital Gain

Edited by Diffzy | Updated on: September 21, 2022

       

Difference Between Dividend and Long-Term Capital Gain Difference Between Dividend and Long-Term Capital Gain

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Introduction

In the present age, stock markets are one of the most famous investment avenues. The profits earned are much higher than interest received on bank deposits, and tax rates are often lower. However, many people are reluctant to opt for these investments due to the risk involved. Dividend, bullish, bearish, long-term capital gains etc., are some of the terms widely associated with the stock market. Dividends and long-term capital gains are both related to yields on the stock market and are often used interchangeably. However, they are significantly different regarding the amount, duration of time they are received, taxation, etc. Thus, investors must understand the difference between the two terms. This article explains both the terms in detail and attempts to draw the significant differences between the two.

Dividend vs Long Term Capital Gain

Long-term capital gain is known as the profit earned when an investor buys an investment, holds it, and sells it after more than one year. A dividend is that part of the profit distributed among its shareholders in the ratio of their shareholding.

The critical difference between dividends and capital gain is that dividends are received by the shareholder only if they have ownership over the investment. In contrast, the long-term capital gain is obtained by shareholders only when they sell their assets. Dividends are paid to the shareholders at pre-determined times of the year, while capital gains are received by shareholders whenever they sell their assets, i.e., at any time of the year. As the name suggests, investors accept long-term capital gains as a lump sum, while dividends are received as smaller amounts/instalments. Capital gain is the appreciation of the value of the investment. At the same time, dividends are paid to the shareholders for the risk assumed by them and for the amount invested in the company.

Difference Between Dividends and Long-Term Capital Gain in Tabular Form

Table: Dividend vs Long Term Capital Gain
Parameters of Comparison
Dividends
Long-Term Capital Gains
Definition
Dividends are a part of a corporation’s profits that are distributed to the shareholders in the ratio of their shareholding.
Long-term capital gain is defined as the profit earned when an investor buys an investment, holds it, and sells it after more than one year.
Period
Dividends are paid periodically (at pre-determined times) quarterly, half-yearly, or annually.
Long-term capital gains are received by investors whenever they sell their investments, and this implies that they may be obtained at any time of the year.
Factors influencing
Dividend distribution is determined by the company's management, keeping in mind the cash flow position, expansion plans, amount of earnings, stability of payments, etc.
Long-term capital gains are solely dependent on market situations, and liquidation of the investment lies in the hands of the investor.
Ownership over investment
Dividends are paid as compensation/reward to the investors for the risk assumed by them and for the amount invested in the company.
Long-term capital gains are received by investors only when they sell their investments in securities. This implies that they are accepted only when the investors lose ownership of the assets.
Amount received
The amount received as a dividend is generally smaller than that obtained as a long-term capital gain. Rewards are paid in instalments.
The amount received as a long-term capital gain is generally more significant than a dividend, and long-term capital gains are obtained in a lump sum.
Alternative name
A dividend is also referred to as distributed profits.
Long-term capital gain is also referred to as long-term financial gain.
     

What is Dividend?

A dividend is that portion of the profit that is distributed to shareholders. The dividend is decided based on the amount of profit of the company must be distributed among the shareholders and how much of it should be retained in the business. The dividends are paid only after payment of tax. Hence, dividends are tax deductible. While the dividend constitutes the current income, re-investment as retained earnings increase the firm's future earning capacity.

Factors influencing the dividend decision of an enterprise:

  1. Amount of Earnings: Dividends are given out of the present and past earnings. Therefore, earnings are a significant determinant of the decision about the dividend. A company that earns more, tends to pay higher amounts of dividends than a company that earns a lesser amount of earnings.
  2. Stability of Earnings: Other things remaining the same; a company with stable earnings is better positioned to declare higher dividends. Against this, a company with unstable incomes will likely pay smaller dividends.
  3. Stability of Dividends: Companies generally follow a policy of stabilizing dividends per share. The increase in dividends is usually made when there is a confidence that their earning potential has increased and not just the current year's earnings. In other words, the dividend per share is not altered if the change in earnings is small or seen to be temporary.
  4. Growth Opportunities: Companies with good growth opportunities retain more money from their earnings for financing the required investment. The dividend in high growth companies is smaller than that in the low- growth companies as low growth companies require lesser amount of retained earnings to finance their investments.
  5. Cash Flow Position: Payment of dividend involves significant outflow of cash. A company may earn profits but may be short on money. Availability of sufficient cash in the company is necessary for the declaring the amount of dividend.
  6. Shareholders' Preference: When declaring dividends, management must keep in mind the shareholders' preferences in this regard. If the shareholders desire that at least a certain amount is paid as a dividend, the companies are likely to declare the same. Some shareholders always depend upon a regular income from their investments. Hence, shareholder’s preference plays a major role in fixing the amount of dividend.
  7. Taxation Policy: The choice between paying dividends and not is affected by the difference in the tax treatment of dividends and retained earnings. If a tax on dividends paid is higher than tax for retaining the profits earned, then the company will naturally reduce the amount paid as a dividend, and vice versa when tax on dividends paid is low. A dividend distribution tax is imposed on companies for paying out their earnings as dividends.
  8. Stock Market Reaction: Generally investors consider increased dividends as good news, and stock prices rise in relation with it. Similarly, a decreased dividends may result in a sharp fall in the share prices of the company. Thus, the potential impact of dividend payments on the company’s share prices is one of the significant factors considered by the management while determining the dividend policy.
  9. Access to Capital Market: Large and well known companies tend to have easy access to capital market sand, therefore, may depend less on retained earnings to finance their growth. These companies generally pay higher dividends than the smaller companies, which have relatively low access to the market.
  10. Legal Constraints: Some provisions of the Companies Act put forward restrictions on pay-outs as dividends. Such provisions must be followed to while declaring the dividend.
  11. Contractual Constraints: Sometimes the lender may impose some restrictions regarding payment of dividends in the future. This is done to ensure sufficient cash flow in the firm to repay the loan amount due to the lender. Thus the companies must not violate the terms of the loan agreement regarding future dividend pay-outs.

What is Long Term Capital Gain?

If an individual buys & holds the shares for more than one year and earns a profit while selling the share, it is known as a long-term capital gain. It is influenced by stock market conditions, and the selling price of the investment also depends on the owner of the investment. It is received as a lump sum amount.

Taxation on Long term capital gain

  1. Before April 2018- If you bought any securities and held them for more than a year before selling them, and you earned a profit on their sale, the tax payable was nil.
  2. After April 2018- The budget stated that any investment held for more than a year and sold after a year at a profit would attract a capital gains tax of a flat 10%.

If the profit earned as a long-term capital gain is less than rupees one lakh, then it is entirely tax-free. If the profit earned is more than 1 lakh, the tax will be charged on the profit amount minus 1 lakh. (Total gain – 1 lakh)

Saving tax on long-term capital gain

  1. Investing in residential properties- If a family sells their ancestral property and earns a long-term capital gain and invests the whole amount in buying another residential property (within one year of sale of the traditional property) or constructing a new residential house (within three years of the sale of the ancestral property) tax is exempted on the whole amount. If the entire amount is not invested, then the amount that is not supported will be subject to taxation.
  2. Investing in bonds- An investor may also support the entire long-term capital gain on bonds issued by the National Highway Authority of India and Rural electrification corporation limited. The list of such bonds is available for free on the website of the Income-tax department of India.
  3. Capital gain account scheme- The capital gains account scheme of the government of India allows investors to be exempted from tax even if they do not invest the amount of long-term capital gain on residential construction/purchase. It allows withdrawal of funds from this accounting scheme only for the purchase or construction of residential accommodation. If the amount is withdrawn for any other purpose, the amount must be utilized within three years after the withdrawal of funds. Any discrepancy in the same will require the investor to file tax on the total amount of long-term capital gain according to the long-term capital gains tax applicable.

Main Differences Between Dividend and Long-Term Capital Gain in Points

  1. A dividend is a part of the company's profit, while long-term capital gains are not involved with the company in any way.
  2. Investor receives dividends if they own the investment. Capital gains are obtained only when the investor sells his investment, i.e., loses ownership over his asset.
  3. Dividends are received in small amounts, while long-term capital gains are obtained in large quantities.
  4. A dividend is received in instalments, while the long-term capital gain is received as a lump sum.
  5. Dividends are decided by the management of the company, while long-term capital gains are dependent on market situations and the liquidity of the asset depends on the owner of the asset.
  6. A dividend is also known as distributed profits; long-term capital gains are also known as long-term financial gains.
  7. Dividends are paid pre-decided times of the year, whereas capital gains are received whenever the investor sells his investment. This means that the investor can receive it at any time of the year.

Conclusion

This article has explained two of the most common yet largely misinterpreted concepts associated with the stock market- dividends and long-term capital gain. Long-term capital gain is known as the profit earned when an investor buys an investment, holds it, and sells it after more than one year. A dividend is that part of the profit which is distributed among its shareholders in the ratio of their shareholding. The significant difference between the two is the time for which they are received and the amount and factors that each of them is influenced by. The article has further explained the concept of dividend in detail and covered the factors that it is influenced by, some of them being- the number of earnings, stability of earnings, and taxation policy. Further, the article has also covered the taxation on a long-term capital gain. It also furnishes on how to save tax on long-term capital gains. These may be used by investors who have just begun their investment journey in the stock market.

References

  1. Class 12 NCERT Business Studies Textbook volume 2
  2. www.groww.com

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"Difference Between Dividend and Long-Term Capital Gain." Diffzy.com, 2022. Sun. 02 Oct. 2022. <https://www.diffzy.com/article/difference-between-dividend-and-long-term-capital-gain-737>.



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