Planning Dividends

Dividends must be linked to profits as disclosed in the balance sheet. Issuing dividends beyond available profits is a breach of the companies act.

Dividend Documents

Distributing profits to shareholders have to be formally recorded by a board resolution and recorded in the minutes. This applies even if there is only one director / shareholder drawing dividends. National insurance does not apply to dividends.

Once declared, dividend certificates must be issued citing the name of the company, the date, the name of the shareholder entitled to the dividend and the value of the dividend tax credit. The value of the tax credit is purely notional and is added to the cash value of the dividend to arrive at a shareholder's gross taxable value.

Dividend Tax Credit

The cash value of the dividend is divided by nine to calculate the tax credit's value. For example:

Cash Value of Dividend £9,000
Divide by 9 (i.e. dividend tax credit) £1,000
Gross Taxable Value of the Dividend £10,000

How Dividends are Taxed

Taxable earned income is first assessed for income tax. For example a shareholder with gross taxable earned income of £20,000 for 2013 / 2014 will have £12,010 (£32,010 less £20,000) left of their basic rate tax threshold to apply to gross taxable dividends.

Tax Threshold (2013 / 14) Gross Rate Tax Credit Net Rate % of Cash Value
To £32,010 10.0% 10% 0.0% 0.0%
£32,010 - £150,000 32.5% 10% 22.5% 25.0%
Greater than £150,000 42.5% 10% 32.5% 36.1%

Dividends and Solvency

The UK Companies Act requires directors to exercise "reasonable care, skill and diligence." In the US this is generally referred to as a "duty of care." These are obligations in law.

Nothing is more important in this respect than protecting the balance sheet. If dividends subsequently result in net assets (equity) going into deficit, the business becomes balance sheet insolvent. However the real danger is much more likely to show up well before that if unsustainable dividends create liquidity and therefore cash flow problems.

Dividends and Liquidity

Cash flow insolvency is by far the most common cause of business failure and often this arises from past inappropriate dividends. It is not good enough therefore to conclude that current profits and available reserves are alone sufficient grounds for issuing dividends if the end result is that the business starts to default on its payments.

When deciding on dividend levels, balance sheet equity and working capital must always come first. That will call for careful planning and forecasting if directors are not to breach their duty of care by putting the business at risk of insolvency. Online planning and forecasting of this kind are what specialises in.

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