What is a Dividend for a Limited Company?
A dividend is a payment made to shareholders. In some countries, it must be declared by law.
There are many ways to set-up a company. This article explores the most common ones. For example, there are limited companies, sole traders, partnerships, LLP, LLPs, etc.
How to issue a dividend
A business with sales of £1 million and costs of £900,000 has a profit margin of 10%. This implies that it makes a loss of £100,000 every year. If the company issues a final dividend of 20%, the directors must make sure that there are sufficient distributable profits left over to cover the cost of the dividend.
The first step is to work out what the annual profit is. To do this, you add up the total sales (£1 million), minus the total costs (£900,000). You then divide the total income by 12. This gives you the average profit per month. Multiply this figure by 52 to find the annual profit.
Next, calculate the amount of tax payable on the profits. This is done by multiplying the taxable profit by 19%.
Finally, subtract the tax liability from the annual profit.
If there are no further distributions, the company will distribute the remaining profits at the end of the financial year. However, if the company wants to continue paying dividends, it needs to carry forward sufficient distributable profits into the next period.
Timing a Limited Company Dividend
A limited company must make a final dividend distribution within 12 months of the close of the financial year. However, it can choose to delay making the payment until the end of the company’s tax period. If you are planning to distribute a dividend to shareholders, you need to consider how much money you want to keep in the company versus what you want to give out to investors. You might find that delaying the payment makes sense because it allows you to retain more cash for future use.
Accounting for a dividend
The accounting rules for dividends are very similar to those used for ordinary income. They include:
• When a dividend is payable, it must be credited to the relevant shareholder account.
• If you receive a dividend, it reduces the amount of capital you hold in the company.
• In most cases, companies pay dividends annually. However, some companies declare dividends less frequently.
Tax on dividends
In the United Kingdom, there is no tax consequence for receiving a distribution from a company. If you receive a distribution in the form of cash, shares, or property, you must include it in gross income. You do not pay taxes on dividends unless you itemize deductions on Schedule A of your federal return.
The UK government has recently announced plans to introduce a dividend withholding tax. The proposed legislation says that if the amount distributed exceeds £200 ($262), you will be required to withhold 20% of the total amount.
If you are subject to UK withholding tax, you must file a declaration with HMRC stating how much of the dividend you intend to deduct.
How dividends can reduce tax burdens
A dividend is taxed differently to ordinary income. If you receive it from a private company, it is treated like a capital gain. This means you pay no tax on the money you receive. However, there are some restrictions on how much you can claim. You cannot claim more than £10,500 a year (£50,000 if married).
You do not have to declare the amount of your dividend. But you must tell HMRC how many shares you hold in the company.
If you own shares in a public company, you may still be able to benefit from the dividend tax rules. These apply when you buy shares directly from the company rather than buying them via another investor.
There are three main types of dividend. They are:
• Ordinary – paid out to shareholders every year.
• Special – paid out only once during the year.
• Retained – held back by the company to cover future expenses.
How dividends interact with the loan account of the director
An overdrawn loan account occurs where the director takes more money out of the corporation than has been paid as a dividend. This is known as an overdraft. Dividends are payments made to shareholders. If you borrow money from a bank, there is a benefit in kind tax charge if the amount borrowed exceeds £10, 000.
Alphabet shares and dividends
Alphabet Inc.’s Class A common stock trades on the New York Stock Exchange under the symbol GOOG. Its Class B common stock trades on NASDAQ under the symbol GOOGL. Shares of both classes of Alphabet stock pay quarterly cash dividends. Both classes of Alphabet stock are considered “equity securities,” meaning that holders of those shares do not receive dividends unless the company pays out additional funds to shareholders.
In 2016, Alphabet announced plans to issue preferred shares to raise money for acquisitions. These shares carry no voting power and cannot be converted into ordinary shares. They also pay a special dividend each quarter.
Tax savings achieved by splitting dividend income with your spouse
In 2007 there was a court cases, “HMRC v Arctic Systems Ltd” where HMRC tried to argue that dividends on shares held by a spouse of an individual who owns a limited company should not be taxed in exactly the same way as normal dividends paid out to shareholders.
The case hinged around whether dividends paid to the spouse of an owner-managed company should be treated as part of his/her personal allowance rather than being subject to corporation tax.
HMRC lost the case, which was good news for owners of limited companies with spouses. If you are married to somebody who pays tax at a rate less than you do, it makes sense to split up the shares because dividends issued to the spouse will enter into his/her self assessment tax return and be taxed independently.
Frequently Asked Questions
When may my business pay dividends?
There aren’t any hard and fixed rules about when it’s acceptable to pay dividends. In fact, many companies don’t even do it. They simply use whatever profit they’ve got left over each quarter to give themselves a little extra cash. This is usually done in one big payment around January or February, or else spread across several smaller ones during the rest of the year.
The reason for doing this is pretty simple. If you’re paying a regular amount of interest on your loans, then you’ll want to make sure that money gets used up quickly. Otherwise, you could end up paying too much. So, rather than just letting those earnings sit idle, you might decide to spend some of them on something useful. For example, you might buy shares in another company, or you might invest in a property. You might even choose to take a small salary cut to make sure that the money goes towards helping your business grow.
However, there isn’t really any rule that says you must always pay a dividend. Some people prefer to keep things simple and just pay themselves once per year. Others feel that this makes it harder to manage the finances properly, especially if they have multiple shareholders. But, whichever method you go for, it’s important to remember that there isn’t any set date when you should start paying dividends.
What about the tax-free Dividend Allowance?
The Government announced changes to dividend tax allowances yesterday. From April 2020, you are able to earn a total of £2,000 per annum in dividend income before any Income Tax is owed. This includes dividends paid by UK companies and those received by individuals resident in the UK.
This is in addition to your personal allowance of £12,570 and your personal tax free allowance of £12,571. If you are over 65, you will receive a further £1,000 personal allowance.
If you do not pay Income Tax, you will still qualify for the dividend tax credit. However, it is important to note that the amount of dividends you can claim against your tax bill will depend on how much capital gains tax you owe.