What Are Dividends And How Do They Work?

Dividends can be an extremely attractive incentive to investors. Here we discuss exactly what dividends are, how they work and if they are a suitable option for your business.

What are dividends?

Dividends are payments made to company shareholders from the organisation’s profits or surplus. There are no rules when dividends are paid, when they are distributed is at the organisation’s discretion, but they may be paid either monthly, quarterly or annually depending on the individual company.

Dividends are an attractive option to many investors and shareholders as they demonstrate the company’s

profitability and qualify the investment opportunity.

It is important to be aware that dividends can still be paid if the company is not profitable within the financial period. In a case where the organisation has not accrued enough profit to pay shareholder dividends, retained earnings may be used. A company must pay tax on profits before dividends are distributed which is different from a salary which is a business expense and therefore is pad before taxes are calculated. In many cases, companies do not offer dividends at all as they choose to invest their profits back into the business for future growth.

The frequency and percentage of dividends should be planned with care. The offer of dividends can be used to entice further investments, however, changes in the schedule and dividend sums for purposes such as reinvestments could be interpreted as a warning signal to savvy investors. Therefore, maintaining communication and business transparency with shareholders is key. If a company suddenly stops paying dividends, it could be interpreted as a signal to investors that the business is in trouble. Although this may be the case, it could also mean that the company directors have decided to reinvest a larger percentage of the profit back into the company to increase growth and revenue and therefore more dividends in the future. Alternatively, from an investor’s perspective companies that pay large dividends may be missing growth opportunities. It is therefore vital that you consider how your dividend payments will be seen by the shareholders. Communication about the business performance is always important.

How do dividends work?

A company’s board of directors consider the distributable reserves of the company and decide the total amount to be distributed. There are two types of dividend: interim dividends and final dividends. Once the directors have calculated the dividend per share, they must hold a board meeting to approve payment of the dividend. A final dividend must be approved at the company’s annual general meeting.

Dividends can only be paid when there is sufficient profit or retained earnings in the company. If a business does not leave enough cash flow to cover day-to-day business expenses and outstanding taxes such as Corporation Tax, the organisation could be liable to penalties from HM Revenue and Customs (HMRC).

When are dividends paid?

There are no official rules as to how frequently dividends can be paid. However, the majority of companies wait at least a quarter or six months before paying out. This gives the company enough time to calculate dividend payments. As long as the company has reserves, a dividend payment can be made at any time.

It is also important for business owners to think carefully about the timing of when dividends are paid as it can have implications on how much tax shareholders pay. If the profitability of the company fluctuates significantly from one year to the next, dividends can be used to create a more even balance sheet.

Are dividends taxed?

HMRC do not charge tax on the first £2000 of dividends a shareholder receives in a tax year. Any dividends over £2000, are treated as the top slice of income so the amount of tax is determined by what Income Tax band the shareholder is in.

The timing of the dividend distribution can also impact when a shareholder needs to pay tax to HMRC. Tax on dividends are often paid the January after the end of the tax year that the dividends were paid. For example, if dividends were paid in February 2019, the tax will be due in January 2020, but dividends received in July 2019 will not be taxed until January 2021. However, if you receive dividends or other self-assessment income regularly you may become liable to payments on account and have to make advance payments towards your tax bill in January and July.

What documents does a company need to produce?

It is necessary to produce two documents whenever a company makes a dividend declaration. The first is board meeting minutes. Companies are required by law to hold a board meeting in order to declare the dividend payment. The minutes from this meeting then need to be kept on record. The complexity of this task depends on the size of the organisation.

The second piece of documentation that must be produced is a dividend voucher. Each shareholder should be provided with a voucher and a copy of each voucher should be retained within the organisation’s records.

The voucher should include the following information:
> The company name
> The name and address of the shareholder
> The number of shares the shareholder owns
> The date the dividend will be paid
> The net dividend amount
> A signature from the company’s director

The board meeting minutes, and the records of dividend vouchers must be available for inspection by HRMC if they ask to see them.

Why do companies pay dividends?

There are many reasons why a company might make the decision to pay dividends. Firstly, dividends are a great way to attract new investors, and can also help with shareholder retention.

If you run and own a limited company, HMRC will expect you to take a salary for any services that you perform. This can be used to ensure entitlement to certain state benefits. After that, dividends are one of the most tax-efficient ways to take money out of your business.

Dividend planning can bring great financial benefits to both shareholders and the business.

Want to know more about dividends and how they can be used successfully and efficiently for your company? Then Wright Vigar are here to help. Our team can advise you on a strategy to suit you, your investors and your company. We will help you consider cash flow, administrative issues and tax savings. Give us a call on 0845 880 5678 or email us on website@wrightvigar.co.uk