Dividend stripping

Dividend stripping is the practice of buying shares a short period before a dividend is declared, called cum-dividend, and then selling them when they go ex-dividend, when the previous owner is entitled to the dividend. On the day the company trades ex-dividend, theoretically the share price drops by the amount of the dividend. However, the experience is that quality companies tend to recover the value of the dividend within a matter of weeks, at which time they trade normally.

This may be done either by an ordinary investor as an investment strategy, or by a company's owners or associates as a tax avoidance strategy.

For an investor, dividend stripping provides dividend income, and a capital loss when the shares fall in value (in normal circumstances) on going ex-dividend. This may be profitable if income is greater than the loss, or if the tax treatment of the two gives an advantage.

Different tax circumstances of different investors is a factor. A tax advantage available to everyone would be expected to show up in the ex-dividend price fall. But an advantage available only to a limited set of investors might not.

In any case the amount of profit on such a transaction is usually small, meaning that it may not be worthwhile after brokerage fees, the risk of holding shares overnight, the market spread, or possible slippage if the market lacks liquidity.

Dividend stripping can be used as a tax avoidance strategy, enabling a company to be distributed company profits to its owners as a capital sum, instead of as a dividend, which offers tax benefits if the effective tax rate on capital gains is lower than for dividends. For example, consider a company called ProfCo wishing to distribute $X, with the help of a stripper called StripperCo.

The net effect for the owners is an $X capital gain. The net effect for StripperCo is nothing, the dividend it receives is income, and its loss on the share trading is a deduction. StripperCo might need to be in the business of share trading to get such a deduction (i.e. treating shares as merchandise instead of capital assets).

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