How Dividends, Stock Splits...etc are accounted for in CFD Trading

Q.: What about Corporate Actions?

A: CFDs in general mirror corporate actions, but don't entitle you to franking credits* or give you the voting rights normally associated with owning the underlying shareholdings. Thus holders of CFDs are still able to participate in corporate actions, including share splits, dividends and rights issues.

In the case of dividends, you will receive cash dividends, if you hold a long CFD position on the relevant ex-dividend date. If you hold a short position, you will need to make a cash payment equivalent to the value of the dividends. For CFDs, the dividend is credited the day the share goes ex-dividend - this is in contrast to a physical shareholder who may be required to wait for up to a month or more before receiving the dividend.

Other corporate actions such as bonus issues, buybacks, takeovers and share splitting are also automatically reflected on your CFD trading account as soon as they are implemented.

* Applies to Australians: A franking credit is basically a credit for tax which the company has already paid on its profits, and investors stand to benefit of this. While the 45-day rule applies to franking credits received, there is some confusion on how it works. Securities must be held 'at risk' for 45 days to get the benefit of the franking credits, but this is only applicable if your franking credits exceed $5,000. It does not apply if your franking credits are less than this.

Q.: What happens if a company pays a dividend?

A: When you buy some stock in a company, usually you will benefit from any dividends that are paid out by the company on those shares. If you trade CFDs over an underlying share, you are not buying the asset itself. However, contracts for differences are built in a way such that you still stand to receive some of the benefits of ownership such as dividends.

When you buy a contract for difference over an underlying share, your CFD trading account will be credited with a certain amount of money that mirrors what the owner of that asset (for instance, a shareholder) would receive as a dividend payment. So the holder of a long CFD will receive, on the ex-dividend date, a payment that equates to the net dividend on the underlying share. The dividend payment is usually reflected on your trading account on the day of its announcement. But note that a short CFD holder will, on the ex-dividend date, be charged the gross dividend by way of a debit to their account. In other words, when you sell a CFD over an underlying financial asset, your CFD trading account will be debited with a similar amount, which is paid to the counterparty.

Make sure you read the Product Disclosure statement and the terms and conditions of the client agreement so you understand how and when dividend payments are made to you and when you must pay them.

Q.: Are CFDs exempt from tax on dividends?

A: No, this is incorrect - returns from dividends on CFDs are subject to tax. CFDs are exempt from stamp duty because they do not involve the trader purchasing shares. But CFDs are not treated as bets, so any profits from them will be liable to capital gains tax, unless they are held in a tax-efficient pension like a Sipp (in the UK).

Q.: Does a holder of a long CFD receive a dividend and imputation credits?

A: Ok, in a nutshell -:

Dividend - Yes.
Imputation Credits - No for most CFD providers.
ASX CFDs - Yes

Q.: Does a holder of a short CFD make a cash payment to the value of the dividend and imputation credits?

A: Yes.

Q.: What about franking credits?

A: A franking credit consists of a tax credit offered by the company with the dividend, when it is about to be paid to shareholders. In practice the company over which the contract for difference is based has paid a percentage of tax on behalf of its shareholders. Fully franked dividends come with a 30% tax credit attached.

In a similar way to shares bought using a margin loan contracts for differences also offer the holder the capability to receive a dividend, however in most circumstances franking credits are not passed on to the holder of a CFD unlike that of a margin loan. The main reason for this is that when holding a CFD, the buyer holds an over-the-counter derivative contract as opposed to the real share. Note that the concept of franking credits is only relevant to Australian companies.

It is also important to keep in mind that when paying the dividend on a position you've short-sold, you may also have to pay the franked part of the dividend. This is because your CFD broker might have hedged your short position in the open market where they had to borrow stock from another owner of the stock, and if this party is located in Australia he would also be entitled to the franking credits. For this reason it is best to check with your CFD broker before short selling an Australian CFD share over dividend periods to check whether you would be liable for this.

In any case many CFD traders only hold their positions open for a brief time period and are not interested franking credits but instead have an interest in making a return from the short term price changes of the contract for difference. It is worth noting that even when buying shares it is necessary to hold the shares for about 47 days (which includes the dividend date) to be eligible for dividend franking credits.

Q.: What happens in a stock split?

When a stock has a split the price usually lowers proportionately to reflect the increase in numbers of shares, is the CFD adjusted in the same way or does it blindly follow the new price?

A: Stock splits happen when companies decide to increase the number of shares circulating in the market, but decrease the share price proportionately, so that the company's market capitalization is not affected. So, for instance if a stock has 1,000 shares outstanding and is trading at $20 per share, a 2-for-1 stock split will double the number of outstanding shares to 2,000, but reprice the shares to $10 per share. Usually, companies do this to improve liquidity of their stock (more shares available to trade in the market) and to make it easier to trade (an investor may find it easier to buy stock at $10 than at $20 a share).

CFD providers normally mirror this process with clients. The CFD is adjusted according to the split, so a 2:1 split in the underlying share will reflect in a 2:1 split in the CFD position.