The dividend policy is also likely to be affected by the owner’s considerations of (a) the tax status of the shareholders, (b) their opportunities of investment, and (c) the dilution of ownership. It is well nigh impossible to establish a policy that will maximize each owner’s wealth. The firm must aim at a dividend policy which has a beneficial effect on the wealth of the majority of shareholders.
The dividend policy of a firm may be dictated by the income tax status of its shareholders. If a firm has a large percentage of owners who are in high tax brackets, its dividend policy share seek to have higher retention. Such a policy will provide it with income in the form capital gains is against dividends. Since capital gains are taxed at a lower rate than dividends, are worth more, after taxes, to the individuals in a high tax bracket. On the other hand, if has a majority of low income shareholders who are in a lower tax bracket, they would pro favour a higher payout of earning, because of the need for current income and the certainty associated with receiving the dividend now, instead of the less certain prospects of a gains later. With effect from financial year 2001, dividend income from Indian corporate firms mutual funds and Unit Trust of India is fully exempt from tax in the hands of the shareholders investors unit holders.