Business to Business Investments: Dividend Returns

Investors and fund managers commonly refer to investment returns in the form of interest or dividends. When distinguishing between the two, an interest-bearing return refers to the borrower paying the returns to the lender in the form of interest as per the investment contract the investment vehicle represents a borrowing contract. Conversely, when investing in a dividend-bearing investment, the technical difference will be where the investment holder will now receive returns in the form of dividends as the investor owns actual equity within the underlying asset, rather than just lending out the required capital.

When looking at investments there will always be various differentiating factors like voting rights, liquidity, returns, collateral, associated risk, tax implications etc. In the South African context, dividends face a fixed tax rate of 20% for individual investors, contrasting with a 0% tax rate for businesses when making investments in other South African companies. The B2B investment model, though less discussed in local South African markets, stands out for its attractiveness, particularly due to the associated tax advantages. The South African government encourages local businesses to acquire equity in other domestic companies, foreseeing potential growth that can stimulate economic activity.

When a business directs unproductive cash from its balance sheet into an investment in another business in the Republic of South Africa, the resulting dividend return from the investment faces a tax rate of 0%. This, in turn, provides the business with the opportunity to offset certain fixed costs, leveraging the tax-efficient strategy encouraged by the South African government.

Example:

Business ABC has a monthly rent expense of R50 000. Business ABC calculates that to cover their yearly rent expense of R600 000, they need to make an investment to the value of R4 687 500, assuming a constant dividend return of 12.8% per year, after fees and tax. (taxed at 0%)

Thus, by simply redirecting cash from the balance sheet to an investment into an equity denominated vehicle, business ABC will be able to cover their annual rent expense for the foreseeable future.

Although interest-bearing instruments enjoy higher authority upon liquidation, the holders are bound by the contract covenants that is diverted into tranches upon payment authority. Whereas dividend investments involve direct ownership into the direct underlying asset.