Dividends

Dividends are paid from after-tax profits to the shareholders of a company. A company pays tax at a 28% rate to Inland Revenue Department (IRD). The after-tax profits (72%) are retained in the company as retained earnings. Retained earnings form part of the company's equity and sit in the balance sheet of the financial statements.

The tax that a company pays to the IRD is called an imputation credit which is important to know and understand. Imputation credits can be lost or forfeited when the shareholding of a company changes (often refered to as shareholder continuity). This is beyond the scope of this article but we will address in a future post.

Imputation credits are essential because when dividends are paid to the shareholders, the tax that the company has already paid IRD (28%) is attached to the dividend, so the shareholder receives that same tax credit. This way, the shareholder is not double taxed on the dividend when it receives it (it gets the 28% imputation credit that the company already paid).

However, the company must also pay dividend withholding tax (DWT) when it pays a dividend. This is an extra 5% tax on top of the 28% it has already paid. When the dividend is declared, the 5% DWT is paid to IRD on the 20th of the month following.

When the shareholder receives the dividend, it will have 33% tax credits attached. If the shareholder has a total income (including all other sources of income such as PAYE income etc.), of between $70 - $180k pa, then no further tax is payable because the dividend already has sufficient (33%) tax credits attached.

If the shareholder has an income of more than $180k pa, then the shareholder will have an extra 6% tax to pay being the difference between the 39% marginal tax rate for income above $180k and the 33% tax credits already attached to the dividend received.

If the shareholder has an income of less than $70k, they will receive a tax refund of the DWT paid.

Tax Details and Legal Requirements:

There are several tax and legal requirements (under the Companies Act 1993) when paying a dividend.

1.Ensure the company has sufficient retained earnings and imputation credits to pay to the shareholders. If there are no imputation credits, the shareholder will pay more tax on the dividend and the company can be charged penalties for having a debit imputation credit account balance.

2.The company is required to have a company minute being a resolution of the directors to pay the dividend.

3.The company is also required to have a solvency certificate which outlines that immediately before and after the distribution, the company will satisfy the solvency test and the company is able to pay its debts as they fall due in the normal course of business and the value of the company's assets is greater than the value of its liabilities including contingent liabilities.

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