Dividends

Dividends are a reward to investors for investing in a company.

The investor buys a share in a company, either from that company or a previous investor.  The business uses the money from the initial investment to help the business make money.

The Directors who run that company then decide whether the money made (the profits), should be paid out to shareholders (as dividends) or reinvested.  If the money is reinvested then the value of the business grows, and the capital value of those shares grows.  Hence investors can gain by either receiving dividends (income) or selling their shares to the next investor at a higher price than they paid (making a capital gain).

Of course not all business make money every year – so income is not guaranteed and there may be capital losses rather than capital gains.

When are Dividends Paid?

The directors of the company decide if and when a dividend is to be paid and of how much.  A dividend is then declared for a class of shareholder and every shareholder receives part of that sum proportional to their shareholding.

Directors must judge if the company has sufficient profits to legally declare dividends, as if not then they may be out of pocket personally as Directors can become liable to repay that dividend to the company, not the investors who received it.  Hence many listed companies only pay dividends twice a year, after their company figures have been audited i.e. checked by an independent third party.

For a smaller company then management accounts are a good idea, to check the legality of proposed dividends, and make sure provisions have been made for all known liabilities e.g. corporation tax.

Directors must also judge the future needs of the business e.g. investment plans as well as potential future liabilities.  If the cash is needed then it should be retained and not paid out to shareholders.

Once directors have made their decision then they offer this proposal to the shareholders for approval prior to payment, although they can choose to pay interim dividends for later ratification by shareholders.

Interim dividends are officially paid/received when cash is made available to the shareholders to spend e.g. transfer to bank account or offset against a loan account.  Final dividends may have a set payment date, when payments are made (and officially received by shareholders), that may differ from the date they are declared at the meeting, and hence become a company liability.

Owner Managed Companies

In some companies the Directors and Shareholders may be the same people, but this does not change the official process above.

If profits are anticipated then interim dividends may be paid regularly and then ratified at the year end when profits are confirmed.

In the past it was standard practice for director/shareholders to draw sums randomly, that built up a director’s loan.  This loan was then “cleared” by an annual dividend declaration.  However, this system is now frowned upon with such loans now needing to be declared in the company accounts and HMRC imposing both interest and tax on such loans.

Minority shareholders in such companies need to be paid or HMRC may decide the directors dividends are wages not dividends.  There is also legislation letting HMRC dispute payments under ABC share arrangements e.g. department managers being given non voting A, B or C shares could have their A, B or C dividends reclassified as bonuses, and hence subject to PAYE tax.

Tax on Dividends

Dividends are paid out of a company’s post tax profits.  But may be subject to tax in the hands of the investor who receives them as income.

An individual has a tax free allowance, currently £500, before needing to pay income tax on the dividends they receive.

If dividends received exceed £500pa then they need to advise HMRC they have tax to pay.

If dividends received exceed £10,000pa then the investor needs to complete a personal tax return to account for this tax.

The tax due depends on other income and may be at 8.75%, 33.75% or 39.35%

Dividends received by a company count as taxable income for the calculation of corporation tax rates on income, but the tax due on dividends is currently 0%.

Happy Investing