The Effect of Deemed Dividend Tax on Dividend Policy of Listed Firms: Evidence from Sri Lanka

Abstract

This study aims to discover the effect of the Deemed Dividend Tax (DDT) on the dividend payout policy of listed firms in Sri Lanka. The sample of the study comprises of 100 firms listed on the Colombo Stock Exchange, excluding financial and power and energy sectors, for the period from2003 to 2014. Further, the study uses the Tobit regression model to analyse the data. The findings of the study suggest that a large number of firms have initiated dividend distribution after the introduction of DDT in 2007 and that dividend payout of firms have increased significantly due to the introduction of DDT. On the other hand, relaxation of DDT threshold in 2011 has prompted firms to decrease the dividend payout, but to a lesser extent compared to the impact of introduction. The findings also discover that dividend income of a firm has become a factor that affects dividend policy of a firm significantly, after the introduction of DDT. Additionally, the findings show that profitability, stability of earnings, leverage and institutional and corporate ownership affect dividend policy of firms in Sri Lanka significantly. However, it is evident that liquidity position of firms is not considered in dividend policy decisions in Sri Lanka, as the firms are more concerned about reducing their tax liability by avoiding DDT. Moreover, the findings support signalling, catering and tax clientele hypotheses, but refute the tax effect hypothesis. In conclusion, the DDT has affected dividend payout policy of listed firms and has altered the factors that affect dividend policy in Sri Lanka.