July 31, 2014

Royal Dutch Shell Class A vs Class B Shares

After I explained the BHP vs BBL shares for BHP Billiton, I realized I may as well dive into the complexity of the Royal Dutch Shell Class A vs Class B shares.  I had originally avoided it when writing about the shares I picked up for the KRIP the other day, but there seems to be an interest in this sort of minutia that I try to avoid because normally, I get passionate about it and people then look at me like I’m nuts.  For those of you who like to understand the actual structure of things, today is your lucky day.

Royal Dutch Shell Used To Be Structured in a Similar Way to BHP Billiton

Back in 1907, the European oil powers grew nervous over John D. Rockefeller setting his sights on their shores.  Two competitors decided to join forces and create a powerhouse that would rival Standard Oil and keep the titan on his side of the pond.  The two companies were N.V. Koninklijke Nederlandsche Petroleum Maatschappij in The Netherlands, and Shell Transport and Trading Company Ltd in the United Kingdom.

The assets were combined, but the two parent companies remained distinct legal entities, traded on the stock exchanges of their respective countries, so you could buy into it whichever way was better for your family; the British liked Shell, which paid out dividends in Pound sterling, while the Dutch liked N.V. Koninklijke Nederlandsche Petroleum Maatschappij, which paid out its dividends in guilders, and later, Euros.  It was a unique artifact of history that served its purpose well for a very long time.  Whether your family owned the Dutch firm or the British firm, your share of the underlying assets remained the same, for all intents and purposes.

The old Royal Dutch Shell legal structure looked like this:

Old Royal Dutch Shell Legal Structure

In 2005, as a result of an accounting scandal that was unthinkable given Shell was one of the most conservative businesses in the world and had compounded stockholder money by more than 14% with dividends reinvested for nearly a century – a feat few other businesses have ever achieved – a massive restructuring took place.

In 2005, Royal Dutch Shell Was Simplified Under One Parent Company with Two Classes of Stock

In this restructuring, the two companies, Shell in England and N.V. Koninklijke Nederlandsche Petroleum Maatschappij in The Netherlands, were delisted and merged under a new, parent company that was created to own the energy conglomerate.  There was now only one business, called Royal Dutch Shell.  It was registered in England and Wales, headquartered in The Netherlands

The New Royal Dutch Shell Structure

The “public shareholders” in the above chart were issued two classes of stock, both of which are identical in practically all meaningful ways, including equal economic and voting rights.

  • Class A shares – These represented the old N.V. Koninklijke Nederlandsche Petroleum Maatschappij.  They are subject to a 15% Dutch withholding tax on dividends unless you are a special exempt pension trust or a special type of exempt organization.  If you ever managed to get your hands on 10% ownership of the business, which only a handful of people on the planet could come up with the tens of billions of dollars to do, your withholding rate would drop to 5%.
  • Class B shares – These represented the old Shell Transport and Trading Company shares.  They are subject to no (0%) withholding tax on dividends.
Royal Dutch Shell Headquarters

Royal Dutch Shell headquarters in The Netherlands. The company generated $467.2 billion in sales and earned $26.8 billion in income last year.
Image courtesy of P.L. van Till at nl.wikipedia under Creative Commons Attribution-Share Alike 3.0 Unported License

The Class A and Class B Shares Were Then Listed in Three Different Countries

To make the shares widely available to investors, Royal Dutch Shell then created 6 listings in 3 countries.  With a few exceptions, which we will discuss later, the same rules apply – the Class A shares are subject to a 15% Dutch withholding tax on dividends, while the Class B shares are not.

The Netherlands
On the listings in The Netherlands, the stocks both trade in Euros.  Dividends are paid by default in Euros on the Class A shares and Pound sterling on the Class B share, though you can elect for the other if you prefer.

  • The Class A shares trade on the Amsterdam Stock Exchange under ticker symbol RDSA.
  • The Class B shares trade on the Amsterdam Stock Exchange under ticker symbol RDSB.

Great Britain
On the listings in London, the stocks both trade in Pound sterling.   Dividends are paid by default in Euros on the Class A shares and Pound sterling on the Class B share, though you can elect for the other if you prefer.

  • The Class A shares trade on the London Stock Exchange under ticker symbol RDSA.
  • The Class B shares trade on the London Stock Exchange under ticker symbol RDSB.

New York
To make it possible for investors in the United States to own shares in the company, Royal Dutch Shell worked with an investment bank, The Bank of New York Mellon, to create a special type of financial instrument.  It deposited shares of the Class A and Class B stock with the bank, then issued receipts against these as proof that they were there (called American Depository Shares, or ADS).  Those ADS were these packaged into new securities called American Depository Receipts (or ADR).

Each ADR represented 2 shares of the underlying Class A or Class B stock.  Dividends are paid in United States dollars.

  • The Class A ADR trade on the New York Stock Exchange under ticker symbol RDS.A.
  • The Class B ADR trade on the New York Stock Exchange under ticker symbol RDS.B

This Presented a Choice of 6 Different Listings for an Investor Buying Stock in Royal Dutch Shell

To summarize again, all in one place, this means if you wanted to buy stock in Royal Dutch Shell, your options were:

  • Class A shares in Amsterdam, quoted in Euros, dividends in Euros (but you can ask for Pound sterling, instead), 15% dividend withholding tax.
  • Class B shares in Amsterdam, quoted in Euros, dividends in Pound sterling (but you can ask for Euros, instead), no dividend withholding tax.
  • Class A shares in London, quoted in Pound sterling, dividends in Euros (but you can ask for Pound sterling, instead), 15% dividend withholding tax.
  • Class B shares in London, quoted in Pound sterling, dividends in Pound sterling (but you can ask for Euros, instead), no dividend withholding tax.
  • Class A ADR in New York, representing 2 shares of the Class A stock, quoted in U.S. dollars, dividends in U.S. dollars, 15% dividend withholding tax
  • Class B ADR in New York, representing 2 shares of the Class B stock, quoted in in U.S. dollars, dividends in U.S. dollars, 0% dividend withholding tax

The Class B shares were subject to no withholding from the Dutch Government, while the Class A shares were unless you were exempt through some special loophole.

This effectively lets an investor in Royal Dutch Shell select whichever is most beneficial for him or her.  You can receive Euros, Pound sterling, or U.S. dollars.  You can have Dutch withholding taxes taken out of your dividends or not.

How the Royal Dutch Shell Class A and Class B Structure Matters To an American Investor Buying Through a Retirement Account

If you are an American investor, living in the United States, and holding your stock through a Traditional IRA, Roth IRA, SEP-IRA, SIMPLE IRA, pension plan, 401(k), 403(b), or other tax-shelter, the Class A stock puts you at a disadvantage in most circumstances because the Dutch government is going to take 15% of your dividends right off the top.  This is a problem because the IRS in the United States will not let you claim those taxes you paid against your income since they are held in a tax shelter.  That means you just lost the money.  It’s gone forever.

That is why  tend to prefer the Royal Dutch Shell Class B shares in any of my U.S. based retirement accounts I control.  I get to enjoy all of the dividend income, and don’t have to pay any of it to any government.  The fresh funds show up constantly throughout the year, unrestricted, sitting there, waiting for me to put them to work in other securities or investments.

There is a rare set of circumstances in which the Class A shares are better for American retirement accounts.  We’ll talk about that unique situation later.

How the Royal Dutch Shell Class A and Class B Structure Matters To an American Investor Buying Through a Regular Brokerage Account

For investors in the United States, if you are buying Royal Dutch Shell through a regular, taxable brokerage account, it matters much less whether you select the Class A or Class B ADR.  If you select the Class A ADR and pay the 15% Dutch withholding tax, you will probably be able to reclaim it when you file your own taxes with the IRS.  To understand the specifics, you’d need to consult with a qualified adviser, as well as read IRS Publication 514 Foreign Tax Credit for Individuals (the link will take you to a PDF version for the 2012 rules; you will need to check future publications if reading this at a later time as the guidelines may change).

How the Royal Dutch Shell Scrip Dividend Program Works

If the Class A ADR look like a better deal at any given moment, you can get around the Dutch withholding tax by signing up for the Scrip dividend program.  Basically, Royal Dutch Shell will agree not to send you any cash, and instead, deposit additional shares of the Class A ADR as a stock dividend into your account.  This will exempt you from the 15% Dutch withholding tax.  The bad news is, the IRS will still want its 15% dividend tax in April, which is unfortunate because most of the time, stock dividends are tax-deferred.  The reason the Scrip dividends are taxes is because you had the option of getting cash if you wanted it, which is enough for the tax man to argue that it was actual income rather than a deferred capital gain.

(For some investors, in some countries around the world, you can use the Scrip dividend program to defer taxes on your Royal Dutch Shell dividends for years when held in a regular taxable brokerage account; even decades.  Were us Americans only so lucky.)

Still, you could use this as a mechanism to take advantage of a rare market dislocation in a tax-deferred account, such as an IRA.  If you suddenly woke up to a world where the Class A shares were trading at a decided disadvantage to the Class B shares, you could buy the Class A shares in your IRA, sign up for the Scrip dividend program, then get the higher yield in this hypothetical alternate reality without paying any taxes to the Dutch or U.S. governments; instead of dividends, you’d see fresh, newly minted shares of the Class A ADR deposited into your account.  If you ever wanted to stop reinvesting the dividends, you could just sell the Class A ADR and swap them into Class B ADR, which would have no tax consequences because you were doing it in a retirement fund.

Did You Spot the Class A Loophole for American Investors Buying Through Retirement Accounts?

The sharp-eyed accountant types out there have just had a blinding light bulb go off over your head.  Yes, you can.  That’s the answer to your question.  Go ahead and let out the scream.  I know you’re excited.  Get it out of your system.

The rest of you, think about it for a moment.

Spot the loophole, yet?

If you want to reinvest your dividends in Royal Dutch Shell, and not use it to fund other investments, and if you are an American investor buying through a tax-sheltered retirement account, and if the dividend yield on the Class A shares, adjusted for the Dutch withholding tax that you now don’t have to pay, exceeds the Class B equivalent yield, you could essentially pocket free money.

It happens more often than you’d think.  For example, at this very moment, the Class A shares yield 4.70%.  Back out the dividend withholding tax (4.7 divided by 0.85) and you get 5.53%.  That is your adjusted dividend yield.  Compare that to the dividend yield on the Class B shares of 5.30%, and you are effectively getting 0.23% in extra, free dividend yield.  If your brokerage firm doesn’t charge you anything for enrollment (it shouldn’t), that type of small advantage matters a lot over 25+ years.  It could add up to many thousands of extra dollars simply because you paid attention at the time of your initial purchase.

(In terms of dollars: At this moment, the Class A ADR are $64.56 and the Class B ADR are $67.05.  If you use the Scrip program to sidestep the Dutch dividend withholding tax, and you are exempt from U.S. taxes because you are in a retirement account, you’re still getting $0.90 in dividends per quarter based on the most recent payment.  Yet, you’re paying less for it through the Class A; hence, the higher yield for those who can take advantage of this magical combination of circumstances.)

Why didn’t I do this?  My approach is different.  I pool my dividends at the bottom of the accounts, and mix the money with fresh deposits.  That combined pile of capital is then redeployed based on the best opportunities I see at the moment.  That means I don’t always reinvest the dividends into the security that originally paid them, though I think that in a diversified portfolio, that is probably best for the average investor.  That is the approach I take for most of the family member accounts I control.

For regular taxable brokerage accounts, I think Royal Dutch Shell should create a special Class C ADR for Americans that only distributes dividends in the form of additional shares, rather than giving the investor the option of receiving cash.  It would create a large tax advantage for investors in the United States, who could convert dividend taxes into deferred capital gains.  Benjamin Graham actually wrote about a hypothetical company doing this back in the 1934 edition of Security Analysis, but one of the only times I’ve come across a firm that issues regular stock dividends is Tootsie Roll Industries, which sends both cash and stock to its owners at the end of the year.

At this point you may be wondering why there is so much complexity.  Royal Dutch Shell is enormous.  Last year, it generated $467.2 billion in sales and earned $26.8 billion in income.  It is truly a multi-national in every sense of the word and transcends countries.  There are very few parallels for an enterprise of this scope in the annuls of human history.  Structuring itself this way gives the various constituent shareholders what they want most – local access to a liquid market for the stock, dividends in a native home currency, and the option to select the most tax efficient method of ownership.

It’s crazy to think how much we, as a civilization, owe the Royal Dutch Shell Companies.  I’m working my way through the 1,800 page, four-volume set The History of Royal Dutch Shell from Oxford University Press.  So many societal advancements came about because of the scientific efforts of the engineers and chemists at this company, who were also involved in advanced chemicals, polymers, distribution, and logistics; discoveries and innovations that reached far beyond the petroleum and natural gas industries.

  • Eric

    This may be a dumb question, but, where is more info on the scrip dividend program? I have a Roth IRA with RDS.A instead of RDS.B. I had no clue that 15% was taken off the top prior to dividend distributions. I thought one class provided greater voting rights versus the other. Either way, thanks for such a fantastic explanation. You are truly a gem for educating people like me such complex subjects in a way that is easy to digest. Seriously, thanks a ton.

  • Bill

    This is intellectual porn for me, I love it haha. I wish you wrote in-depth like this on more subjects more often.

    I left a comment in a recent post about not being able to purchase shares of RDS.A or B through my Roth IRA. When I opened a chat with my roth IRA provider I got a rather vague reply that didn’t really explain the limitation on me. For whatever reason, even though the RDS.B is listed on the NYSE, when I try to pull up the stock quote and attempt to purchase an order, no information comes up and I get an error. Nothing you can do, I know, just wondering if you’ve ever had any issues like this? I contacted them once again and am waiting for a reply to help me with the issue. I want to own some at such great value! >.<

    • http://www.joshuakennon.com/ Joshua Kennon

      Ha! You don’t think I’d run off half of the readers? I already have people write me and tell me they like the site but it’s too over their head. This is the sort of stuff that makes my heart flutter and my brain start looking for exploits. You and I are a tiny minority on this, I think. Unless I’m mistaken and there are a bunch of secretly obsessive geeks out there.

      As to your question: Some antiquated brokerage firms don’t use the proper “RDS.A” and “RDS.B” format from the post-merger but instead use “RDS-A” and “RDS-B”. Still others who are really out of date use “RDS/A” and “RDS/B”. I’ve even seen a handful use “RDSA” and “RDSB”. Give the alternatives a try and let me know what happens. If still nothing works, I’d be concerned. Is this a mainstream brokerage firm? There is absolutely no reason – zero – that you shouldn’t be able to buy the ADR listed on the NYSE. I have never encountered such a thing.

      P.S. A few seconds ago, I just added a few paragraphs to the end of this article explaining how you could exploit a loophole to use the Class A shares to get a bigger yield in a Roth IRA or comparable retirement account. It’s counter-intuitive, but I figured if I’m going to get into this level of minutia, I may as well go all in.

      • Bill

        Bingo! “RDS’B” how weird. And yeah it’s a mainstream. To find the quote, you need to type in RDS’B (I tried RDS.B and RDS-B) but throughout the stock quote everything is typed out as “RDS.B” Now to decide if I should swap my CVX for RDS.B for the long-term.

        The link was the recent one about putting together a retirement account for your family member – and you replied with “I am partial to the Class B ADS that trade in New York under ticker symbol RDS.B or RDS-B depending on the broker. ” Apparently theres five ways brokers will spell it out, in my case RDS’B lol.

        And to be honest, I’ve been reading your blog sense you had 210k page views and I very often get frustrated that I’m not able to get more information/detail from you on a subject because you explain things in such a great way lol. Perhaps a “for more detail – check out this/these links or books” on certain posts? Just an idea, though as mentioned above – I’d much rather get that extra info through your words… Speaking of… when’s that book coming out?? ~.^

        • Bill

          Quick question – When reading the Scrip ADS pdf, in the ‘how do I get started?’ part, they say “If you are a registered ADS Holder on the books of the Depositary…” If I purchase shares of RDS.A through my Roth IRA, would I already be, or how would I go about, ‘registering’ my ownership of ADS shares “on the books of the Depositary”?

      • Michael Starke

        I love this type of post, so count me among the “secretly obsessive geeks.”

        • Scott McCarthy

          Whereas I fall into the “openly obsessive geeks” category. lol

      • Joel

        While I do understand the “simpler” posts, I always read these in depth ones too. Everything is strange and over your head until you learn it. Isn’t learning why people read blogs like this?

  • Matt

    “Why didn’t I do this? My approach is different. I pool my dividends at the bottom of the accounts, and mix the money with fresh deposits. That combined pile of capital is then redeployed based on the best opportunities I see at the moment.”

    Could you effectively do the same thing even using the class A shares? Buy the class A shares and enroll in the scrip dividend program, then just sell off the excess shares as they are deposited into your account. Since it is a tax deferred account, this sale wouldn’t trigger a tax, and you could then pool the money to buy a block of stock and leave yourself with the same ownership in Shell? (Although just out of curiousity, what would be the basis of the stock dividend shares?) It seems the only counter to this would be if the IRS said that the sale was effectively the equivalent to a cash dividend and taxed you on it anyway.

    • Scott McCarthy

      You would have to weigh the frictional costs (paying commissions) against the value of the discount. While it may make sense if you have a large enough stake, the discount is a one-off benefit, against a perpetual stream of frictional expenses.

  • Bill

    Also – According to MSN Money – RDS.A currently has a 4.79 yield and the RDS.B has a 5.41… Not sure why the difference in figures from yours to mine?

    • Tyler Phillips

      The important thing is the actual amount of the dividend, which is currently $3.06 per year on Class A shares after the 15% Dutch withholding tax. MSN Money must be using some delayed share price to calculate the yield.

      A yield of 4.79% would indicate a share price of $63.88, which the Class A shares have definitely been at in the past few days. At this moment, Class A shares are trading for $65.18 so the yield would be 4.69%. ($3.06/$65.18)

  • Samir

    Joshua – this is a fantastic explanation. I am a big fan of your blog. I have read most of your articles (even the cooking ones !! ) and some of the fundamental entries multiple times in the last 2 months.

    Thanks for the great work you are doing in educating the masses. I very much agree with the comment that somebody made below about this being “intellectual porn”.

  • SK

    Thanks for the article. Appreciate what you do. – One more layer of consideration (correct me if I’m mistaken), if opting for the RDS.A shares and scrip dividend program, a U.S. (IRA) investor would need a minimum amount of shares to reap most of the tax benefit. It appears that Shell only applies the cash dividend equivalent towards whole shares. Thus any residue would then be taxed at 15%. Looking at today’s price/ div a U.S investor would need at least 75 shares to avoid having the entire quarter’s dividend taxed. As the share lot increased the tax consequence would be less meaningful, but it appears there would still be some tax ‘leakage’ each quarter.

    • Bill

      A side note – check with whoever you have your IRA or other plan through, to make sure they’ll be able to register your shares. I was unable to take advantage of the Scrip because the shares I purchased in my Roth IRA are considered “Street name”.

      • SK

        Thanks. The rep at my brokerage claimed it could be done,
        but you never know. I’ll probably give Shell/ BNY Mellon a call as well to see
        how it’s initiated on their end.

  • European Capitalist

    Joshua, I enjoy your blog a lot, thanks for putting so much effort into it. I’ve been a lurker so far, but there is an aspect to British stocks that I believe you haven’t mentioned in this post and others dedicated to British stocks, that might be of value to some of your readers. It’s a tax nuance that would prevent me from holding RDS.B shares in a tax-sheltered retirement account if they were available to me in my home country Austria (which they are unfortunately not) and does prevent me from holding any British stocks on my company books, instead opting to hold them privately in fully taxable accounts.

    The UK corporation tax used to be an imputation system until 1999, meaning that a natural person receiving a dividend also got an income tax credit that represented the corporation tax already paid on the profits out of which the dividends are paid, so profits were essentially taxed once at the level of the natural person, with the tax paid by the company only being an advance (withholding) tax. When the classical system (were profits are taxed at both the company and shareholder level separately) was reintroduced in 1999, a 10% tax credit stayed however with only minor limitations (you can’t ask for the money to be reimbursed if you fall in a 0% tax bracket).

    I love the UK. Not only do they choose to have 0% withholding tax (even despite the fact that in most cases their double taxation agreement would allow them to charge up to 15%), they put the icing on the cake by giving you a tax credit on top. It is the only country I know of that does this.

    If I held UK stocks in a tax-free account then I’d be throwing away the 10% tax credit. We don’t have IRAs in Austria, but when my company holds stocks it doesn’t pay tax on the dividends anyway – otherwise it would be double taxation of profits.

    I am not sure if the IRS in the US will recognize the UK tax credit, but within the EU it should be possible to use the tax credit to offset the tax liability just like the more common withholding tax is used to do so. Some governments might be more cooperative in recognizing the tax credit than others, but from my personal understanding of EU law you should have a right to this in any EU country. Here is how it works in Austria:

    Much like Switzerland Austria has banking secrecy written into its constitution, so private citizens don’t have to pay investment income tax directly to the tax office at the end of the tax year. Instead the banks subtract a 25% flat tax on any interest, dividends and capital gains earned, credit only 75% to your account and give the 25% anonymously to the tax man. Up to 15% withholding tax is recognized automatically and offsets the tax liability, so when the Netherlands withholds 15% then the Austrian bank will charge another 10% local tax for a total of 25%. Unfortunately when a country like France charges more than 15% withholding tax you still have to jump through bureaucratic French hoops to get your money back.

    In the case of the UK however Austrian banks credit you with 111.11% of the dividend amount, then assume 10% British withholding tax (=10% tax credit), and proceed to subtract 15% Austrian tax to make up the difference to the required 25%. Because of the way the tax credit is calculated you end up paying a little more than 15%: 100/0.9=111.11*0.15=16.67% tax or in other words a net dividend of 83.33%. In the case of RDS.B which payed a 0.45 dollar dividend last quarter you get to keep 37.4985 cents instead of just 33.75 cent. If I put the stock in a company I’d get to keep all of the 45 cents, but if I would then distribute a dividend to myself with that money I’d be liable for the full 25% tax. It might make sense to keep the stocks in a company if the money is left there for a long time, since the untaxed 45 cents have more compounding power, but because I also want to hold stocks from other countries the proper allocation is to put British stocks into private ownership and stocks from other countries into the company.

    • Don Cleveland

      I dont get it. how do we know the $.90 dividend isnt paid and THEN 15% is taken out of it when it hits your brokerage account? Where does it say the dividend is actually $.90 + 15% = $1.035

      • European Capitalist

        It’s not $0.90 + 15% unfortunately. The tax credit is only 10%, but 10% of the total so you divide by 0.9 instead of multiplying by 1.1 (which is better because 10% of $1 is 10 cent, but 10% of $0.90 is only 9 cents). So in case of an ADS the total amount for tax calculation purposes would be 1$ of which 90 cents are payable and 10 cents go towards paying your taxes.

        You can find information on this at the shell website in the dividend section: http://www.shell.com/global/aboutshell/investor/dividend-information/latest-announcement.html

        They are talking about the ordinary shares on the website though, so you’ll have to translate the numbers to ADS shares. in the case of ordinary shares the 45 cent dividend is bumped up to 50 cents.

        Quote from the website:

        Shareholders resident in the United Kingdom, receiving cash dividends on B Shares through the Dividend Access Mechanism, are entitled to a tax credit. This tax credit is not repayable. Non-residents may also be entitled to a tax credit, if double tax arrangements between the United Kingdom and their country of residence so provide, or if they are eligible for relief given to non-residents with certain special connections with the United Kingdom or to nationals of states in the European Economic Area.

        The amount of tax credit is 10/90ths of the cash dividend, the tax credit referable to the second quarter 2013 interim dividend of US$0.45 is US$0.05 per ordinary share and the dividend and tax credit together amount to US$0.50.

        I don’t know if your country honors the tax credit, neither do I know if it applies to ADS or only to ordinary shares. In my case I hold the ordinary shares and I live in Austria and the tax credit reduces my tax burden on the dividends from 25% of $0.45 to 16.67% which is awesome because it results in a lot more compounding power. We don’t have tax-sheltered retirement accounts in Austria as they exist in the US, so we have to take advantage of every additional compounding power we can get our hands on.

        I’d love to hear from Joshua whether he knows if it is possible to take advantage of the tax credit in the US. I haven’t read it, but the US/UK double taxation agreement is probably a favorable one.

  • Bill

    Joshua,

    Can we get your impressions on the 1,800 page historical compendium now that you’ve had some time with it? I’ve thought about picking it up for a bit of a case study, though its expensive. Thanks.

    -Bill