Return of capital

Return of capital (ROC) refers to payments back to "capital owners" (shareholders, partners, unitholders) that exceed the growth (net income/taxable income) of a business. It should not be confused with return on capital which measures a 'rate of return'.

The ROC effectively shrinks the firm's equity in the same way that all distributions do. It is a transfer of value from the company to the owner. In an efficient market, the stock's price will fall by an amount equal to the distribution. Most public companies pay out only a percentage of their income as dividends. In some industries it is common to pay ROC.

Contents

Tax consequences

There will be tax consequences that are specific to individual countries. As examples only:

Misconceptions

It is wrong to think that the concept of ROC is only a tax issue. It is an economic measure. But the measurement of ROC resulting from accounting financial statements will be different from the tax man's ROC. While accountants try to measure the economic reality (in theory at least), governments may allow businesses to expense the cost of capital assets faster, in order to stimulate investments. This difference in the speed of expensing will result in different ROC values.

It is wrong for the investor to think of the ROC as income. Income is a measure of how much "better off" you are now than you were then. The ROC simply transfers assets from the business to the investor. As the investor benefits from the payment, the business shrinks, and the investor's interest in that business shrinks. An example is the only way to illustrate this.

Example

You start a delivery business with one employee and one contract. Your initial investment of $12,000 goes to buy a vehicle.

At the end of each year:

At the end of four years:

Conclusions

Time value of money

Some people dismiss ROC (treating it as income) with the argument that the full cash is received and reinvested (by the business or by the shareholder receiving it). It thereby generates more income and compounds. Therefore ROC is not a "real" expense.

There are several problems with this argument.