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What is meant by Tax Neutrality of Dividends?
Tax Neutral Investors
In the share market, there are always three types of investors −
The first type of investor considers dividends to be always good.
The second type thinks dividends are always bad.
And the third type does not have any opinion about dividends.
The high-payout investors prefer the first option because they can save taxes by opting for current dividends. The low-payout groups may like the second group, while a third group of tax neutral investors have no preferences because they don’t have to pay any tax on their investments.
The third group of investors are actually tax neutral in nature. Since the applied taxes is zero in case of the third type of shareholders, they are neutral to the kind of tax differentials
Tax neutrality refers to a situation where the investors don’t have to pay any taxes on their investment in shares. This group of investors are always risk averse and they tend to choose stocks that are free from tax differential in any given time-period.
Tax Neutrality of Dividends
Tax neutrality of dividends refers to a situation where investors have to pay no tax on their dividend income.
Usually, dividends attract a lower tax than capital gains but in some instances, the dividends may be free from any tax that may be applicable in the financial system of the relevant country where the transactions are made.
Tax neutral dividends usually are backed by governments and there is no taxation levied on such shares.
Tax neutral dividends may look attractive on the face value but they usually offer limited returns. That is, the tax neutral dividends are offered for shares that are less uncertain about their future outlook. As the tax on given dividends is neutral, the shareholders needn’t pay any tax on their dividend incomes.
Although less frequently applied, tax neutral dividends exist in the common market. In fact, all three types of shares are plentiful in the share markets and it is the choice of investors to buy tax neutral shares that offer a given return after a limited period of existence.
Conclusion
Although investors prefer to earn the maximum from shares, there are some who prefer stocks that offer limited but stable earnings. It is also a fact that until the trade-off between taxation and dividend payouts remains, there will be profitable and loss-making shares that offer different tax credentials for the owners.
Tax neutrality is also of importance since there is a group of investors that look for no tax differential, and this group of investors is less careful about the differentials than the investors who seek to maximize their earnings by the dividend payouts.
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