Shell's Dividend Bombshell

An announcement late last week by oil company Shell (LSE: RDSB) has so far caused relatively few ripples among private investors. As time goes by, I suspect that might change.

In the short term at least, it's possible to view Shell's announcement as moderately investor-friendly towards UK shareholders, many of whom buy the high-yielding oil company's shares for their income-generating properties. In the longer term? Well, judge for yourself.

Briefly, what the company has done is to make a change to its existing DRIP -- or dividend reinvestment plan -- scheme, whereby shareholders can elect to take their dividends as shares, rather than as cash.

For investors who don't actually need dividends to live on, DRIP schemes are often popular, because they are a relatively painless way of building up a stake in a company, free of commission and dealing charges.

And the Shell scheme certainly ticks those boxes, as the company stressed when I spoke to it yesterday. Other boxes, though, are most definitely left unticked.

Goodbye DRIP, hello scrip

• The existing DRIP scheme -- in Europe, the UK and the United States -- is being scrapped, with effect from the third quarter interim dividend for 2010.
  
  
• It's being replaced by a scrip scheme: instead of the company buying its shares in the open market and handing them to investors, it's simply going to create new ones. So investors who don't take up the scrip option will see their stake in the company gradually diluted.
  
  
• Here in the UK, investors generally hold Shell 'B' shares, rather than Shell 'A' shares, where dividends are denominated in euros (although optionally payable in sterling), and are subject to Dutch withholding tax at 15%.
  
  
• But under the new scrip scheme, all newly-issued shares will be 'A' shares, even if the original holding was in 'B' shares. The award of those shares won't be subject to Dutch withholding tax, though, as the dividend is not being paid in cash.
  
  
• And shareholders electing to receive the new 'A' shares will not be subject to any further UK tax -- even higher rate taxpayers. How so? Because under current UK tax rules, new shares received under the scrip programme will be treated as a non‑taxable capital receipt, rather than income.

What's not to like?

Well, quite a few things, actually. And although the pages and pages of information I've waded through certainly don't set out to hide anything, their very length -- and some occasionally impenetrable jargon -- does little to help private investors figure out the best course of action.

So here are a few nuggets to mull over:

• Quarterly dividends will in future be payable seven business days later than at present, due to the need to calculate an average trading 'strike price' for the scrip offer.
  
  
• Irrespective of that strike price, the acquisition price for capital gains tax purposes will be the original cost of the original shareholding -- the logic being that the new shares are free.
  
  
• Unless you participate, your stake in Shell will be diluted.
  
  
• Investors will now have two holdings to manage. The scrip offer has to be elected for twice, for example: once on the original 'B' shares, and again on the new 'A' shares. And when selling, dealing costs are doubled.
  
  
• Investors wanting to discontinue their participation in the new scrip programme and revert to cash dividends will now have to pay Dutch withholding tax at 15%. In other words, as the lengthy Q&A document explains, a £90 dividend will be paid as £76.50 -- leaving the taxpayer to try and reclaim the missing £13.50 through their tax return, via the UK's double taxation treaty with the Netherlands. At the very least, this is additional paperwork and delay.

The bottom line

Higher-rate UK taxpayers not reliant on Shell dividends for their immediate income needs probably have cause for celebration. At a stroke -- at least, on my reading of the rules -- they're gaining through not paying additional tax on their dividends.