Chapter 2 - The different tax treatments under DRPs and PDPs

How dividend reinvestment plans work

2.1 Under a dividend reinvestment plan (DRP), the company provides shareholders with the option of reinvesting their cash dividends in shares of the company. This can be advantageous for the company, allowing it to maintain a dividend payment policy, while providing an opportunity to increase cash retentions. DRPs are also convenient for shareholders, offering a convenient method for them to reinvest their cash dividends in a company, at a lower cost and effort than purchasing shares on the market. There appear to be two types of DRPs.

Standard DRPs

2.2 Under a standard DRP, when a dividend is declared, shareholders are offered the option of receiving a cash dividend or receiving a bonus issue of shares. The option is generally exercisable before the dividend is paid. In the standard case, a cash dividend is paid unless the shareholder opts otherwise. Receipt of cash is the default option.

2.3 Distributions of cash or shares under a DRP are treated as a taxable dividend in the hands of the shareholder. If a shareholder chooses to receive a bonus issue of shares instead of a cash dividend the issue is treated as a “bonus issue in lieu”, which is a dividend for tax purposes. Imputation credits may be attached to distributions under a DRP.


2.4 A PDP reverses the priority of these options. Under a PDP, the company formally issues shares to all dividend recipients. However, shareholders are able to elect, before the dividend is paid, to have their shares immediately repurchased by the company, for an amount equal to the cash value of the dividend. If the shareholder does not make an election, the default option is to receive shares.

2.5 PDPs have proven successful in New Zealand for obtaining reinvestment rates between 60 to 90 percent of dividends declared. This rate is very high compared to that achieved under DRPs. This result is particularly attractive to companies in the current economic and financial environment as it increases cash retention and reduces the need for companies to raise external financing to fund operations and investment programmes.

2.6 The tax treatment of distributions under a PDP was the subject of a specific Inland Revenue product ruling in 2005. [1] The ruling held that a distribution of shares under a PDP is treated as a non-taxable bonus issue and consequently does not constitute a dividend in the hands of the shareholder. This ruling was made subject to certain conditions – in particular, that the company making the bonus issue has sufficient credits in its imputation credit account to have fully imputed a cash dividend equal to the bonus issue not redeemed.

Lack of certainty and consistency

2.7 Taxpayers have expressed concern about the uncertainty in relation to the tax treatment of PDPs under current tax law. The uncertainty arises because PDPs do not appear to be explicitly covered by the legislation.

2.8 There appears to be a lack of consistency between the two types of share issues. Under standard DRPs, shareholders choose between receiving cash dividends or shares. Both are taxed as dividends in the shareholders’ hands, and imputation credits can be attached.

2.9 PDPs, on the other hand, make use of a different form of transaction, to provide shareholders with the option of receiving shares or cash. In this case, when the shareholder chooses to retain shares the retention of the shares may not be taxable as a dividend. For certain taxpayers, this may provide a tax advantage relative to those investing under standard DRPs. Shareholders on higher tax rates would face a lower tax impost than that applied to other dividend reinvestment plans.

Adherence to the rules underpinning the imputation system

2.10 The imputation system is based upon a number of rules applying to the taxation of income that is earned by a company and then distributed to shareholders. The rules are:

  • As far as possible, taxing income derived through companies at the tax rates of the shareholders who own the company at the time the income is derived.
  • Ensuring that New Zealand source-basis taxation is retained – that is, taxing non-residents on the income that is derived through their investments in New Zealand.
  • Providing no credit for income that has not been subject to company tax (unimputed income), so that the full amount of the underlying income is subject to shareholder level tax.
  • Ensuring imputation credits attached to dividends reflect the proportionate share of income earned by the company on behalf of the shareholder. A series of rules are provided to ensure that imputation credits cannot be “streamed” to taxpayers who can make the greatest use of them.

2.11 The appropriate taxation of DRPs, including PDPs, should reflect these principles.


1 A Product Ruling was issued to SkyCity Consolidated Group in December 2005. See Tax Information Bulletin (Volume 18, Number 2).