In the previous blog for our ‘Commonly asked accounting questions’ series, we looked at what a creditor and debtor was. This time we’re focusing on what a dividend is, how you pay them and how you can create them within your Clear Books account.
What is a dividend?
A dividend is distribution (divvy up) of a limited company’s profits to its shareholders. The profits used are those available after a company has paid all its expenses and Corporation Tax.
With many small companies being owned and run by one or two people, who are both directors and shareholders, it’s important to differentiate the two roles for this purpose.
Directors runs the business and will take a salary for that work. This is one of the expenses taken out of profits before the company’s tax bill is calculated and can, within reason, be any sum the directors decide is reasonable.
Shareholders do nothing in the business and wait for the directors to report to them over how the company has done and, as mentioned above, will take their money out of whatever profits are left. It’s important to point out that the dividends available are limited by the profits available.
Dividends are calculated as a whole and then divided up amongst the shareholders according to the proportion of shares they each hold. For example, if a shareholder owns 30% of your company shares, they will receive 30% of each dividend distribution.
Most large companies pay dividends every 6 or 12 months whereas many small companies will pay them quarterly or monthly.
How are dividends paid?
To pay a dividend to your shareholders, approved by directors, there are a couple of steps that are necessary to take.
- Hold a meeting of the directors to decide on what dividend can be paid, recording minutes of the meeting*.
- Pay the dividends (or make them available) to each shareholder and provide them with a voucher as evidence for their tax return.
*Instead of having to call a meeting, it is also possible for the directors to approve the dividends in a “written resolution”, signed by all the directors.
Dividend tax credits
As dividends are paid out of the company’s taxed income they have, for decades, been treated as having already been taxed on the shareholder and so come with a “tax credit”.
For many years this tax credit has been 10%, i.e if a shareholder receives a dividend of £900, a tax credit of £100 is attached so that they are treated as having received a gross dividend of £1,000 on which they have suffered 10% tax, leaving them with £900 in their pocket.
This system is abolished from 6 April 2016 and so a £900 dividend will represent the shareholder’s gross income.
How are dividends taxed?
Up to 5 April 2016:
- For a basic rate taxpayer, the rate of tax applicable to gross dividends is 10% meaning that, with the tax credit, no further tax is payable.
- For a higher rate taxpayer, the rate of tax applicable to the gross dividends is 32.5%, against which you can offset the 10% tax credit, leaving an extra 22.5% to pay.
- For an additional rate taxpayer, the rate of tax applicable to the gross dividends is 37.5%, against which you can offset the 10% tax credit, leaving an extra 27.5% to pay.
From 6 April 2016:
The first £5,000 of taxable dividends carry a 0% tax rate, with the remainder being taxed:
- For a basic rate taxpayer, at 7.5%
- For a higher rate taxpayer, at 32.5%
- For an additional rate taxpayer, at 38.1%
How you can create dividends in Clear Books
Unlike most software providers our dividends tool enables you to mimic the process of creating dividends set out above. You enter details of the shareholders and their respective shareholdings and then generate a dividend.
This is apportioned to each shareholder creating both the minutes of the meeting and the voucher to be given to each shareholder. The sum owed to each shareholder is recorded in a “shareholder’s dividend” account in the books, with the total dividend reducing the company’s profits
Finally, at the tax year end, the system can provide each shareholder with a summary of the dividends paid to them in the year.
Take a look at our support guides for step-by-step information on using Clear Books’ dividends tool.