Cisco's Dividend Decision: Tax Missive to D.C.

If there's one thing to learn from the overwhelming opposition this week to a dividend at Cisco SystemsCSCO, it's that the tax system needs to change before tech companies jump on the dividend bandwagon.

That was the message Cisco CEO John Chambers seemed to be sending to Washington and the consensus of investors and analysts who follow Cisco. Still, although shareholders defeated a dividend proposal by a 10-to-1 ratio, there may be a few other nuances to the defeat, including a poorly crafted proposal and entrenched perception of Cisco as a growth stock.

"The double-taxation issue is there, and it's real," said CIBC World Markets analyst Stephen Kamman, who has a sector perform rating on Cisco. "With Cisco committed to a [stock] buyback, I think people did not want to see that [double taxation]." His firm hasn't done any banking with the company.

Cisco is authorized to buy back $6.1 billion in shares, a move that would help boost earnings per share by reducing shares outstanding. For the time being, that's apparently preferable to investors, who would have to pay taxes if they received dividends. That's double taxation, because companies currently enjoy no tax deduction when they pay out dividends; rather, they pay dividends after paying taxes.

"If dividends were certain not to be double-taxed, we would look at it," Cisco CEO John Chambers said this week in what some viewed as a message to Washington. Legislators there are toying with the idea of eliminating that double taxation. That's a more likely possibility with the Republican takeover of Congress next year.

"Unless the Republicans change the double-taxation law, there's not going to be an impetus to have a dividend from MicrosoftMSFT or Cisco," predicted Ian Murray, a portfolio manager with Straus Asset Management in New York, who owns shares of Microsoft, but not Cisco.