The effects of a tax dividend cut on payout policies: Canadian evidence

Abstract

Purpose – The purpose of this paper is to examine whether the significant dividend tax rate reduction for individual investors in Canada in 2006 affected firms’ payout policies. Design/methodology/approach – Using regression models, the authors examine the impact of the 2006 dividend tax cut on dividends and share repurchases in Canadian listed firms from 2003 to 2008. The authors also ran a multinomial logit regression to examine choices between payout policies. Findings – Following the tax cut, firms increased their dividend payouts, with larger increases for firms in which shareholders benefited from the reduced tax rate. However, the 2006 tax cut appears to have had no negative effect on distributions through share repurchases. After the 2006 dividend tax cut, firms owned by shareholders subject to dividend taxes were more likely to use a combination of distribution mechanisms than share repurchases only, dividends only, or no payouts. Practical implications – Shareholders’ tax preferences are an important factor for firms to consider when designing payout distribution policies. Following the 2006 dividend tax cut, firms increased their dividend payouts. Social implications – The findings provide tax regulators with insight into how firms react to tax reform. They suggest that firms adapt their payout policy in the face of: a noteworthy dividend tax cut (6.2 per cent); a dividend tax cut that does not encourage tax arbitrage; and a dividend tax cut that does not economically favour dividend payment over share repurchases. Originality/value – The paper considers the 2006 dividend tax rate cut in Canada, which presents a number of significant features that allow capturing the effect of a tax cut on payout policies.