Discretionary dividends are those paid, not by contractual obligation, but at the discretion of the issuer of the underlying instruments. Where there are hybrid securities--instruments with some equity and some debt features--the presence of discretion in the issuance of dividends is critical to classification.
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Mapletree Investments Pte Ltd., a real estate company in Singapore, explained its accounting policies in the notes to its financial statement for the year ending March 31, 2005. It said, "Ordinary shares and redeemable preference shares with discretionary dividends are classified as equity. Preference shares which carry non-discretionary dividend obligations are classified as liabilities."
The general distinction implied in those words holds for systems of corporate law around the world.
The term has a distinct additional meaning in Canada, where it refers to the discretionary decision of a corporation to pay dividends to one class of stock rather than another. Couples often split their disparate incomes using discretionary dividends issued by a family company.
Supreme Court of Canada
In 1998, the Supreme Court of Canada considered and rejected a challenge to this practice brought by the tax authorities. "[T]axpayers are entitled to arrange their affairs for the sole purpose of achieving a favorable position regarding taxation," the court said.