Introduction: The Scrip Dividend Problem for American Shareholders
A scrip dividend is a dividend paid in new shares instead of cash, and for an American living in Britain it creates a tax event on two returns even though no money reaches your bank account. Many large British companies offer shareholders the choice each time they declare a dividend. You tick a box with the registrar, and new shares appear in your holding a few weeks later.
The attraction is obvious. You compound your position without paying dealing commission, and the company keeps its cash. However, the absence of cash leads many investors to assume nothing taxable has happened. That assumption is wrong in Britain, and it is wrong in America too. Worse still, the two countries measure the income differently, set the base cost of the new shares differently, and recognise it in different tax years.
At TaxYork, we prepare US and UK returns for high-net-worth Americans, investment bankers and company owners in Britain. In our experience, a scrip dividend is one of the most commonly missed items on a US expat return, because no Form 1099-DIV ever arrives and the UK registrar statement looks like a corporate action rather than income. This guide explains exactly how each country taxes the shares, where the figures diverge, how to claim the foreign tax credit, and how to correct earlier years if you have missed it.
What a Scrip Dividend Actually Is
A scrip dividend is an offer by a company to issue new fully paid shares in place of a declared cash dividend. The number of shares you receive equals the cash you would have received divided by a reference price, which is usually the average share price over a few days around the ex-dividend date. Any residual cash that cannot buy a whole share is normally carried forward to the next scrip or paid out.
Some companies offer an "enhanced" version, where the shares are deliberately worth more than the cash alternative to encourage take-up. Others run a dividend reinvestment plan, or DRIP, which looks similar but works differently in law. As a result, the label on the registrar's form matters far less than the legal mechanics underneath, and the mechanics drive the tax on both sides of the Atlantic.
Why Americans Abroad Are Caught Twice
A US citizen is taxed by the IRS on worldwide income wherever they live. Meanwhile, a UK resident is taxed by HMRC on dividends from UK companies under the Income Tax (Trading and Other Income) Act 2005. Consequently, an American resident in London holds a scrip dividend that falls squarely within both systems. The US-UK treaty, described in the US-UK income tax treaty text published by the US Treasury, preserves the US right to tax its citizens through the saving clause, so relief comes only through the foreign tax credit.
How HMRC Taxes a Scrip Dividend
HMRC taxes a scrip dividend from a UK-resident company as "stock dividend income" under sections 409 to 414A of ITTOIA 2005. The HMRC Savings and Investment Manual at SAIM5150 confirms that this charge applies where a UK-resident company issues share capital because the shareholder chose additional shares instead of a cash dividend. In other words, the UK treats your election as income, not as a free bonus issue.
The Cash Equivalent and the 15% Test
The amount taxed is the "cash equivalent" of the new shares. Under section 412 of ITTOIA 2005, the cash equivalent is normally the cash dividend you gave up. However, if the difference between that cash alternative and the market value of the new shares equals or exceeds 15% of the market value, the market value replaces the cash figure. For listed shares, market value is measured on the date of first dealing.
This rule matters most for an enhanced scrip dividend. Suppose the cash alternative is £10,000 but the shares are worth £12,000. The £2,000 gap is 16.7% of market value, so HMRC taxes £12,000 rather than £10,000. Conversely, where the share price drifts only slightly between the reference period and first dealing, HMRC taxes the cash figure. The HMRC guidance at SAIM5170 sets out the same test in plain terms.
When the Income Arises and the Rates That Apply
According to SAIM5160, stock dividend income arises on the earliest date the company is required to issue the shares. It is then taxed exactly like a cash dividend. For 2026/27, the official UK income tax rates and allowances set the dividend ordinary rate at 10.75%, the upper rate at 35.75% and the additional rate at 39.35%, with a £500 dividend allowance. The two lower rates rose by two percentage points from 6 April 2026, while the additional rate stayed at 39.35%.
Therefore, a high earner in London pays 39.35% on a scrip dividend just as on cash. Furthermore, no UK tax is withheld at source on dividends, so the entire liability falls into your Self Assessment balancing payment and, often, your payments on account. You report it in the dividends section of your return, as the GOV.UK guide to tax on dividends explains.
The UK Base Cost of the New Shares
Because you have been taxed on income, HMRC gives you a matching base cost. Under section 142 of the Taxation of Chargeable Gains Act 1992, an individual is treated as acquiring the new shares for consideration equal to the cash equivalent. The Capital Gains Manual at CG58750 explains that the issue is treated as a new acquisition rather than a reorganisation, so the shares are not simply absorbed into your original cost. When you later sell, UK capital gains tax applies at 18% or 24% on shares, after the £3,000 annual exempt amount.
How the IRS Taxes a Scrip Dividend
The US starting point looks generous. Under section 305(a) of the Internal Revenue Code, a distribution of a company's own stock is generally not income. However, section 305(b)(1) overrides that rule whenever any shareholder can elect to receive cash or other property instead. A scrip dividend is, by definition, an election between cash and shares. Accordingly, it falls outside the exemption and becomes a distribution of property taxed under section 301.
Section 305(b)(1) and the Election Rule
The regulations go further than many investors expect. Treasury Regulation 1.305-2 applies section 301 to every shareholder once an election exists, including shareholders who take shares and those who never return the election form at all. Similarly, IRS Publication 550 states that stock dividends are taxable if "you or any other shareholder" can choose cash instead. Hence, you cannot avoid US tax simply by choosing shares.
Measuring the Income at Fair Market Value
Here the two countries part company. Publication 550 tells you to include the fair market value of the shares "at the time of distribution" in your income. The IRS does not use the cash alternative, and it has no 15% tolerance. Consequently, whenever the share price on the distribution date differs from the reference price, your US income differs from your UK income, even for an ordinary scrip dividend with no enhancement.
Moreover, the US measures income in dollars. You convert the sterling value at the exchange rate on the distribution date, so currency movement adds a second layer of difference. For a large holding, the gap between the UK cash equivalent and the US fair market value can easily reach several thousand pounds in a single year.
US Basis and Holding Period
Your US basis in the new shares equals the fair market value you included in income, as Publication 550 confirms. In addition, the holding period of the new shares starts the day after distribution rather than tracking back to your original purchase. That means a sale within a year produces a short-term gain on the scrip lot, taxed at ordinary rates, even though your main holding is long-term. Therefore, you should track each scrip dividend as a separate lot with its own date and its own dollar basis.
Qualified Dividend Status and the 3.8% Surcharge
A dividend from a UK-resident company is usually a qualified dividend, because the UK company is eligible for the benefits of the treaty and so meets the qualified foreign corporation test in Publication 550. As a result, the US rate on a scrip dividend is normally 0%, 15% or 20%, rather than ordinary rates. However, you must meet the 61-day holding period around the ex-dividend date, and the company must not be a passive foreign investment company. The IRS guidance on dividends in Topic 404 summarises those conditions.
On top of the capital rate, high earners pay the 3.8% net investment income tax on dividends. UK tax cannot be credited against that surcharge. The Federal Circuit confirmed on 31 August 2026 that treaty credits reach only regular income tax, not the separate chapter that imposes the 3.8% charge. Consequently, even a fully credited scrip dividend often leaves a small residual US bill.
Where the Two Systems Collide
Most double tax problems come from one country taxing and the other not. A scrip dividend is subtler: both countries tax it, but they disagree on the amount, the timing and the cost of the shares. Each disagreement has a practical consequence for your foreign tax credit.
Different Values for the Same Shares
The UK taxes the cash equivalent unless the 15% test is triggered. The US taxes fair market value on the distribution date. If the shares rise between the reference period and issue, the US figure exceeds the UK figure, and the foreign tax rate on the US-measured income falls. If the shares fall, the reverse happens. In either case, your Form 1116 must use the US-measured income with the actual UK tax paid, not the UK income figure.
Different Tax Years
The UK tax year runs from 6 April to 5 April, while the US year is the calendar year. Therefore, a scrip dividend issued in February 2027 falls in the UK year 2026/27 but the US year 2027. The UK tax on it is not paid until 31 January 2028. If you claim credits on a paid basis, the timing can drift by a full year. Most UK-resident Americans benefit from electing the accrued basis, which aligns the credit with the year the tax relates to, but that election binds future years too.
Different Base Costs on a Later Sale
Because the UK base cost is the cash equivalent and the US basis is fair market value in dollars, the gain on a later sale differs between the two returns. The UK gain may be larger or smaller than the US gain, and the currency element adds a further twist. As our guide to reporting UK share sales on Form 8949 explains, carrying the UK figure onto the US return is one of the most common basis errors we correct.
When the Issuer Is Not a UK-Resident Company
The UK stock dividend rules apply only where the issuing company is resident in the United Kingdom. Some London-listed groups are not UK tax resident, either because they moved their tax residence abroad or because they were never resident here. For their shareholders, the UK analysis of a scrip dividend changes completely, while the US analysis stays the same.
Capital Treatment in Britain
Where the issuer is not UK-resident, sections 409 to 414A do not bite. Companies in this position have published shareholder tax notices explaining that HMRC confirmed, in their particular cases, that the new shares are a reorganisation of share capital under sections 126 to 128 of TCGA 1992. On that analysis, a UK holder pays no income tax on receipt, and the new shares take a share of the original base cost with no uplift. The UK tax only arrives later, as capital gains tax, when you sell.
Full Taxation in America
The IRS takes no notice of the UK classification. Section 305(b)(1) still applies because the shareholder had a cash election. Accordingly, you include the fair market value as a dividend in the year of issue. If the company is not resident in a treaty country and its shares are not readily tradable in the United States, the dividend may not be qualified, which pushes it to ordinary rates of up to 37% plus 3.8%. Crucially, there is no UK tax in that year to credit, so the US tax is a real cash cost.
The Mismatch on Exit
The damage continues when you sell. Britain then taxes the whole value of the new shares as a capital gain, because they carried no extra base cost. America, meanwhile, taxes only the growth above your fair market value basis. Therefore, the UK capital gains tax often exceeds the US tax on the same sale, and the excess credit may expire unused in the passive basket. For this type of scrip dividend, taking cash is frequently the better choice for an American shareholder.
Scrip Dividends, DRIPs and ISAs
Shareholders often treat a scrip dividend, a dividend reinvestment plan and an ISA-held holding as interchangeable. They are not, and each produces a different result on your US return.
Dividend Reinvestment Plans
A DRIP pays you a cash dividend and then uses that cash to buy existing shares in the market on your behalf. Both countries tax a normal cash dividend, and your base cost is simply the purchase price. The IRS adds one wrinkle: if a company plan buys shares at a discount, Publication 550 requires you to include the discount in income and to take the full fair market value as basis. Otherwise, a DRIP aligns far better across the two returns than a scrip dividend does.
Shares Held in a Stocks and Shares ISA
An individual savings account shelters dividends and gains from UK tax. However, the IRS does not recognise the ISA wrapper. A scrip dividend received inside an ISA is therefore tax-free in Britain but fully taxable in America, with no UK tax to credit. In our experience, this is the single largest source of missed reporting on ISA accounts held by Americans, because the platform statement shows no cash income at all.
Fractional Entitlements and Residual Cash
Where your entitlement does not divide into whole shares, the company usually carries the residual cash forward or pays it out. Publication 550 treats cash received for fractional shares as proceeds from a sale, reported on Form 8949. Separately, a scrip certificate that you can redeem for cash is taxable at fair market value when you receive it. These amounts are small, but they belong on the return.
Reporting a Scrip Dividend on Your US Return
No UK registrar issues a Form 1099-DIV, so you must build the figures yourself. Firstly, you report the fair market value on Schedule B and on the ordinary and qualified dividend lines of Form 1040. Secondly, you claim the UK tax on Form 1116 in the passive category, or the general category if the high-tax kickout applies.
Form 1116 and the High-Tax Kickout
Passive income that bears foreign tax above the highest US rate of 37% moves automatically into the general basket. A UK additional-rate taxpayer pays 39.35% on the UK cash equivalent, but the kickout test compares UK tax with the US-measured income. Where fair market value exceeds the cash equivalent, the effective rate can fall below 37%, keeping the income passive. Our analysis of foreign tax credit basket errors explains why that placement affects your carryforwards. IRS Publication 514 covers the underlying rules.
FBAR and Form 8938
Shares held through a UK broker or nominee account sit in a foreign financial account, so the account counts towards the FinCEN FBAR threshold of $10,000. Certificated shares held directly on the company register are not an account for FBAR, but they are specified foreign financial assets for Form 8938. Our guide to directly held foreign stock on Form 8938 explains how to value them. Every scrip dividend increases the maximum value you must report.
Correcting Missed Scrip Income
If you have omitted a scrip dividend in earlier years, you can correct it on Form 1040-X. The normal amendment window is three years, but a claim for a foreign tax credit benefits from a special ten-year window under section 6511(d)(3). Our walkthrough on amending a wrong US expat return sets out the process. Where the omission spans several years and other assets, a broader review of your UK general investment account reporting is usually worthwhile.
Case Study: A London Banker Who Took Shares Instead of Cash
Eleanor is a US citizen working in investment banking in London. She is a UK additional-rate taxpayer and files jointly in the United States. She holds 400,000 shares in a FTSE 100 company that is resident in the UK, through a UK nominee account. In March 2026, the company declared a dividend of 12p per share and offered a scrip dividend at a reference price of £6.00.
The UK Calculation
Eleanor's cash alternative is £48,000, so she receives 8,000 new shares. On the first dealing day, the shares trade at £6.40, giving a market value of £51,200. The difference of £3,200 is only 6.25% of market value, below the 15% threshold. Therefore, HMRC taxes the cash equivalent of £48,000. Eleanor's dividend allowance is already used, so she pays 39.35%, or £18,888, in her Self Assessment for 2025/26. Her UK base cost for the 8,000 shares is £48,000.
The US Calculation
The IRS taxes fair market value on the distribution date, which is £51,200. At an exchange rate of $1.27, that is $65,024 of qualified dividend income. At 20%, the regular US tax is $13,005, and the 3.8% surcharge adds $2,471. Her UK tax of £18,888 converts to $23,988. Hence, the effective foreign rate on US-measured income is 36.9%, which stays below the 37% kickout and keeps the income passive.
The Credit and the Residual Bill
The UK tax fully eliminates the $13,005 of regular US tax on this scrip dividend, and the excess $10,983 joins her passive carryforward. However, nothing offsets the $2,471 surcharge, so she pays that in cash. Furthermore, her US basis in the new shares is $65,024, not the sterling £48,000 her UK broker shows.
The Sale Two Years Later
In 2028, Eleanor sells the 8,000 shares at £7.00, receiving £56,000 at $1.30, or $72,800. Her US long-term gain is $7,776. In Britain, assuming for simplicity that the shares are matched at their own cost, her gain is £8,000, taxed at 24% for £1,920, after her annual exempt amount is used elsewhere. Without careful lot tracking, her software would have used a basis of $60,960 and overstated the US gain by $4,064. Accordingly, a correct record of each scrip dividend saved her both tax and an amended return.
How TaxYork Can Help
TaxYork provides comprehensive US and UK tax return preparation for Americans in Britain with substantial share portfolios. We identify every scrip dividend, enhanced scrip and DRIP in your registrar and broker records, and we calculate the separate UK cash equivalent and US fair market value for each one. We then build the Form 1116 with the correct basket and timing, and we keep a lot-by-lot basis ledger in both currencies.
Where earlier years were missed, we prepare amended US returns, claim the foreign tax credits still in time, and bring your FBAR and Form 8938 reporting up to date. In addition, we coordinate your UK Self Assessment so that both returns describe the same shares consistently. Our tax treaty optimisation service and FBAR and FATCA reporting service work alongside our core US tax returns for expats, while our cross-border planning team reviews whether cash or shares suits you before the next election deadline.
Conclusion
A scrip dividend feels like a free top-up to your holding, yet for an American in Britain it is fully taxable on both returns. HMRC taxes the cash equivalent unless the 15% test applies, while the IRS taxes fair market value under section 305(b)(1). The two systems then diverge on timing, base cost and currency, and the 3.8% surcharge sits outside the credit entirely.
Above all, the issuer's residence changes everything. A UK-resident company produces matched income tax in both countries, which the foreign tax credit largely resolves. A non-UK-resident issuer can produce US dividend tax with no UK credit, followed by a UK capital gain years later. Therefore, review each election before you make it, record every scrip dividend as a separate lot, and correct any missed years while the credit windows remain open.
Contact Us
If you have taken shares instead of cash, or you are unsure whether earlier years were reported correctly, our specialists can review your registrar statements and both returns. Please book a consultation with our team, email hello@taxyork.com or call 020 3488 8606. We will confirm your position, quantify any exposure and prepare the filings you need.
Disclaimer
This article is for general information only and does not constitute tax or legal advice. The rules on stock dividends, share reorganisations, foreign tax credits and treaty relief are complex and depend on your specific facts, the residence of the issuing company and your elections. The case study is illustrative, simplified and uses approximate figures and exchange rates. You should obtain professional advice tailored to your circumstances before acting on any information in this article. TaxYork accepts no liability for any loss arising from reliance on this content.