After a change in government rules, the shareholders of Omega Ltd. keep a smaller part of each rupee received as dividend than of each rupee gained as capital gains. What should Omega Ltd. do about its dividend, and which factor affecting the dividend decision is at work?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Pay less by way of dividends; the factor is taxation policy.
Option (1) Pay less by way of dividends; the factor is taxation policy. — Correct. Under taxation policy, the choice between paying dividend and retaining profit depends on the difference in the tax treatment of dividends and capital gains. Omega’s shareholders now keep less of each rupee of dividend. So the company should pay less by way of dividends and retain more.
Option (2) Pay higher dividends; the factor is taxation policy. — Incorrect. Higher dividends suit a time when the tax on dividends is relatively lower. Here that tax is higher, so a higher dividend leaves shareholders with less.
Option (3) Pay less by way of dividends; the factor is legal constraints. — Incorrect. The action is right, but legal constraints are provisions of the Companies Act that restrict payouts as dividend. The change here is in how dividends are taxed.
Option (4) Pay higher dividends; the factor is legal constraints. — Incorrect. Both parts are wrong. A higher tax on dividends calls for a lower dividend, and the factor is taxation policy.
NCERT (2026-27 Edition): “(g) Taxation Policy: The choice between the payment of dividend and retaining the earnings is, to some extent, affected by the difference in the tax treatment of dividends and capital gains. If tax on dividend is higher, it is better to pay less by way of dividends. As compared to this, higher dividends may be declared if tax rates are relatively lower. …” “(j) Legal Constraints: Certain provisions of the Companies Act place restrictions on payouts as dividend. Such provisions must be adhered to while declaring the dividend.” |