When a company makes a profit there are two ways to use the money. The company can either reinvest the profit into the business, which is called retained earnings, or it can distribute the profits to shareholders in the company in the form of dividends. A number of shareholders and directors of companies choose to be paid a lower salary and take the rest of their earnings as dividends. As the dividends are taxed at a lower rate, this will maximise income.
A dividend is allocated as a fixed amount for each share and dividends are distributed in accordance to the shares owned by each shareholder. Public limited companies typically pay dividends on a fixed schedule, but may declare a dividend at any time during the year, often called a special dividend. A dividend is usually paid electronically to the shareholders bank account and a receipt sent separately showing the dividend and tax credit. Dividend reinvestment plans are often offered by public limited companies. There are other types of dividend but a cash dividend is the typical method of payment. Cash dividends are a type of investment income and taxable in the year in which they are paid. The rate of tax depends on the income of a shareholder and their typical rate of tax. A tax credit is given to allow for the tax already paid or to be paid on the company profit. If a shareholder is a basic rate taxpayer, their will be no further tax to pay. If a shareholder is liable to pay tax at 40 percent or the additional rate of 50 percent, there will be further tax to pay. The dividend income is declared on the self assessment tax return at the end of the year.
When a dividend is declared it must be approved by the company’s board of directors before it can be paid out to shareholders. The day that the board of directors announces that it is to pay dividends is known as the declaration date. At this time a liability is created and is recorded on the company’s books. This indicates that the company owes the money to the shareholders. On the declaration date, the dates record and payment will be announced by the board.
All shareholders registered in the stockholders of record on or before the date of record will be entitled to receive a dividend. Payment date is the date when the dividends are physically paid to shareholders.
When a shareholder receives a dividend a tax credit is given to represent the tax that is deemed to have been paid, thus avoiding a shareholder being taxed twice on the same income. However, the tax credit is not reclaimable, which can result in a non taxpayer being taxed on the dividend income.
Shares in a public limited company may be purchased by the general public and can be traded on the Stock Exchange. The initial value of the shares on sale for a public limited company must be more than £50,000. Typically, the dividends will be paid either annually, twice a year or each quarter. A private limited company cannot offer shares to the general public and can be valued at any amount. Dividends may be paid more frequently than a public limited company, perhaps on a monthly basis. However, the company must have profits to allow this.
A private limited company may want to change its status to a PLC so that it can offer shares to the general public, especially if looking for finance. If a company wants to expand, this option becomes particularly attractive. Professional advice is recommended for anyone buying or selling shares.
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An experienced business and finance writer, sometimes moonlighting as a fiction writer and blogger.