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

Q:What about Corporate Actions?

A: Dividends are payments made by a company to its shareholders. When a company earns a profit, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be paid to the shareholders of the company as a dividend. Paying dividends is not an expense; rather, it is the division of an asset among shareholders. Many companies retain a portion of their earnings and pay the remainder as a dividend. Publicly-traded companies usually pay dividends on a fixed schedule, but may declare a dividend at any time, sometimes called a special dividend to distinguish it from a regular one.

Dividends are usually settled on a cash basis, as a payment from the company to the customer. They can also take the form of shares in the company (either newly-created shares or existing shares bought in the market), and many companies offer dividend reinvestment plans, which automatically use the cash dividend to purchase additional shares for the shareholder.

Since owning a contract for difference is practically identical to owning the actual share, you are also entitled to dividends as per the share holders above. The major difference is that all dividends are cleared in cash, there are no reinvestment schemes or any other sort of substitute available.

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.

Let’s say I’ve got my Vodafone shares, I think they’re going to go up and I’m planning on holding them but over the course of the next six weeks these shares are going to go ex-dividend. What happens? 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. So if for example there was a 10-for-one share split and it went from £2 to 20p, you would have more CFDs. And the same applies to rights issues as well.

* 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.

If you are long the stock then you receive the dividends on CFDs and if you short the stock then you pay the dividends. The price the following day will adjust for the price of that dividend as it will in the underlying market. There’s nothing more to it than that. You can expand that to corporate actions too – it’s generally the same whether you’re holding the CFDs or the shares, except for the voting rights.

Q:What happens if a company pays a dividend?

A: When trading share CFDs, one question that arises is as follows; is the CFD trader entitled to the dividends from a company it holds share CFDs in? The answer is yes.

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

Share CFDs offer investors a less costly way of dealing in company shares and has the added benefit of providing dividend payments to those traders in long positions. CFDs incur various charges and credits, such as overnight financing costs, and dividends are best thought as another credit (or charge) to your CFD trading account. Traders looking to use share CFDs should be aware of three important dates in relation to dividends and share CFDs. Firstly, the ex-dividend date, which is the last day when you can buy a stock/share CFD and receive the next dividend. Secondly, the record date, when the investors must hold their shares until to qualify for receiving the dividend. This is normally three days after the ex-dividend date. Finally, the payment date when the dividend check is received by the shareholder, which can be around two weeks after the record date.

One important consideration is whether you are in a long or short position with share CFDs. If you are in a long position, the dividend can be thought of as a credit to your trading account. A percentage, or the full amount, of the announced cash dividend is credited to the trading account by the CFD provider when the company declares an ex-dividend date. To receive the dividend, the trader must have held the share or at least entered the long position a day before the ex-dividend date. It is not necessary to own the share CFD on the payment date to receive the dividend payment.

Investors must also consider the change in the share price on the ex-dividend date. This happens to reflect the amount of the dividend. On the ex-dividend date, the value of the shares may drop by nearly as much as the amount of the dividend. If you are in a long share CFD position, your trading account will post a loss while receiving the dividend. A short position generates profit offsetting the dividend debit for the trading account. Usually, the share price does not adjust by the total amount of the dividend and there should only be a marginal adjustment to the total value of positions, whether in a long or short position.

The dividend policy of each CFD provider varies and investors should be aware of how their provider’s policies can affect investment outcomes. Investors should look into whether they can participate in dividend payments and other corporate actions such as bonus issues, subdivisions, consolidations, etc.

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

A: Yes. When a trader is in a short position with a share CFD, the dividend is best thought of as a charge to the trading account. If a trader has a short position the day before an ex-dividend date, the trading account is debited an amount equal to the dividend the business day following the ex-dividend date. The credit or charges are posted to trading accounts for both short and long positions, appearing as separate entries, ensuring convenience when preparing tax returns.

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.

Q:In case of a rights issue if I buy the rights in CFDs can i take part in the rights exercise?

Recently I have been looking into trading CFDs off the back of corporate actions like rights issues. For example: I notice that when rights are issued that a lot of the time they are tradable. The rights price then fluctuates dependent on a number of factors and I want to know, Is there a way to trade the fluctuations in price in CFD format? Also, if i buy the rights in CFDs can i take part in the rights exercise?

A: If you hold a position in a stock and there is a corporate action, your position will get automatically adjusted after the exchange has closed for the day. When the exchange opens the next day, your position will have already been adjusted.

If you hold rights to expiry you will be offered the option to exercise them into an underlying share position. They would then be expired at zero and a new position in the underlying would be booked from the rights issue price. Of course you can take advantage of any price fluctuations there might be in any market.