Procedures in declaring dividends and calculating the dividend tax credit and understanding the position with regard to income tax on dividends.
Declaring a Dividend
The articles of association of each company limited by shares determines the formal procedures to be followed in respect of declaring company dividends, In the distribution of the company net profit after corporation tax dividends represent the amount of profit paid to shareholders with the balance being retained profits of the business.
The decision to declare a dividend is normally recommended by the board of directors and must be approved by shareholders, usually by ordinary resolution at a general meeting as stated in the articles of association. In practice small limited company directors are often the shareholders and provided they agree the rate of dividends it is not necessary to hold a special meeting.
When a dividend is declared by the board meeting at which the shareholders attend or a general meeting of shareholders the minutes should state the amount of dividend declared. The dividend also has to be entered into the company financial accounts and a dividend voucher raised for each shareholder entitled to receive the profits distribution which states the dividend paid as net and shows the dividend tax credit.
The model set of articles of association, Table A, state the interim dividends may be declared by the limited company. This rule allows the company to distribute dividends to shareholders at any time and as frequently as approved by the shareholders subject to the company have sufficient funds to make the payment.
Dividends Calculation and Income Tax on Dividends
One essential requirement is that the total dividend payment is less than the net taxable profit earned by the company after deduction of all expenses and corporation tax. Breaking this rule might mean dividends had been paid out of untaxed profit which could form the basis for an HMRC investigation relating to distributions from the company for tax avoidance purposes.
Provided the company has a residue of retained profits which have been subject to corporation tax dividends can be distributed from those revenue reserves to maintain dividend payments which the current year profits might not have justified.
Maintaining accurate up to date financial company accounts by accounting for dividends is important if multi interim dividends are to be declared to avoid potential tax issues. The dividend declared should take into account the corporation tax to be deducted from the net taxable profit.
For a small limited company where the directors are the shareholders the corporation tax dividend income tax balance is often the most tax efficient method of withdrawing income from the business.
The tax implications of balancing the salary paid, corporation tax liability and declaring dividends is in effect a dividend tax calculator and important in the dividends calculation.
The gross salary is paid net after paye deductions for income tax which is currently 20 per cent at standard rate, and 40 per cent at the higher income tax rate, employee national insurance contributions of 11.5 per cent and employers national insurance of 12.5 per cent and the staring point for the dividend tax calculator..
With corporation tax rate for small companies currently 21 per cent .increasing to 22 per cent from April 2009 the effect on not withdrawing a salary much beyond the personal tax allowance is significant.
For a small company with the financial year ending after April 2009 the amount of money not taken as salary increases the corporation tax liability by 22 per cent but assuming the salary would be below the higher threshold saves the company 12.8 per cent employers national insurance reducing the net tax effect to the company at just 9.2 per cent
Considering the net salary paid to that director and shareholder would after income tax and employee national insurance at the standard rate be just 68.5 per cent the paye deductions far outweigh the increased corporation tax liability.
Dividend Tax Rate
Dividend tax rate payable is according to the taxpayers income. The dividend tax rate payable is 10 per cent for standard tax rate payers and 32.5 per cent for higher tax rate payers.
Dividend Tax Credit
When the dividend is paid the company also issues a dividend voucher stating the amount paid and the dividend tax credit. The dividend paid is quoted net of the 10 per cent dividend tax credit. For example a £10,000 dividend payment is the net amount after deducting the £1,111 dividend taxes credit.
For tax return purposes dividend income is the total of the actual dividend paid plus the dividend tax credit. The dividends tax credit is set off against the income tax liability resulting in zero additional tax to be paid by the basic rate taxpayer.
Tax payers cannot claim the 10 per cent income tax dividends credit if your taxable income is less than your personal tax allowance as no tax is payable. This is because the 10 per cent income tax dividends tax rate is a credit against any income tax due, not a tax refund.
IR35 Dividend Income
One further issue regarding the tax on dividends is tf the director and shareholder are subject to the IR35 rules then the income from the company must be taken as salary. Dividend income received by someone under the IR35 rules would be subject to being re-assessed as paye income with the potential damaging consequences of back dating and reclassifying that dividend income received as paye dividends income resulting in back taxes and interest penalties.