ACCA Advanced Financial Management (AFM) Practice Exam

When dividends are taxed more heavily than capital gains, investors typically prefer low dividends. This preference arises because higher taxation on dividends means that after-tax income from dividends is reduced, making them less attractive compared to capital gains, which are usually taxed at a lower rate.

Investors focus on maximizing their after-tax returns. When dividends are subject to greater tax liabilities, they may favor strategies that emphasize capital gains, which provide a more favorable tax treatment. By opting for low dividends, investors can keep more capital invested, allowing for potential appreciation and deferred tax liabilities until they ultimately realize those gains.

This tax structure incentivizes companies to retain earnings or prioritize share buybacks rather than issuing high dividends. As a result, investors looking to optimize their after-tax returns would indeed prefer lower dividends in this scenario.