What's the deal with Dividends and imputation credits?

Declaring Dividends in a Company

Dividends are a way for companies to distribute profits to shareholders. However, before a company can declare a dividend, directors must ensure that a solvency test is met. This means:

1. The company will still be able to pay its debts as they come due, and
2. The company’s assets are greater than its liabilities (including contingent liabilities).

Another common option for distributing profit is to pay a shareholder salary.

Understanding Dividends and Withholding Tax

It's important to know that dividends are income for the shareholder but originate from a company’s after-tax profits. Without certain measures, this could lead to double taxation—once on the company’s profit and again on the dividend received by the shareholder. To prevent this, imputation credits (ICs) are used to offset part of the tax. These credits reflect tax already paid by the company, passed onto shareholders with dividends, generally at a 28% rate.

However, dividends are taxed at 33%, which means the company must "top-up" the 5% difference. This top-up is known as Dividend Withholding Tax (DWT), ensuring that the shareholder is taxed correctly on the full dividend amount. Once dividends are fully imputed, shareholders can use the ICs and DWT as tax credits to reduce their tax liability.

If you would like to learn about other type of withholding tax, refer to our blog: What Is Withholding Tax?

Example of Dividend and Withholding Tax Calculation

Let’s break down how withholding tax works with a simplified example:

• Company Profit (2024): $200,000
• Company Tax (28%): $56,000
• Net Dividend Available (after tax): $144,000
• Additional 5% DWT on Gross Dividend: $10,000 (paid by the company)

For the shareholder:

• Gross Dividend Received: $200,000
• Minus Company Tax Credit (ICs): -$56,000
• Minus DWT Credit: -$10,000

Note: Shareholders may owe additional tax if their total income places them in the 39% tax bracket - see Key Considerations below.

Imputation Credit Account (ICA)

To track tax credits available to be attached to dividends, companies maintain an Imputation Credit Account (ICA). This logs all tax payments, refunds, and credits attached to dividends.

Here’s an example of how an ICA might work:

Opening Balance (April 2024): $4,500
+ Income Tax Paid: $56,000
+RWT Paid on Interest: $2,600
= Maximum ICs for Dividends: $63,100

- ICs Attached to Dividends Paid: -$56,000 (as above)
= Closing Balance (March 2025): $7,100

If a company ends the year with a debit balance in its ICA, it must pay Inland Revenue the outstanding balance plus a 10% penalty.

Planning for Dividends: Key Considerations

39% Personal Tax Rate

If your total income exceeds $180,000 annually, you’ll be taxed at 39% on any income over this threshold. Dividends only come with tax credits at 33%. This means you’ll have an additional 6% tax to pay on the excess when filing your personal return.

39% Trust Tax Rate

With Trust tax rate changes (effective 1 April 2024), there is potential to be taxed up to 39% when net income exceeds $10,000. However, there may be an opportunity to distribute the dividend to beneficiaries who are at lower tax rates. 

Shareholder Continuity

To maintain imputation credits, a company must retain at least 66% of the same shareholders from the date the tax was paid to when the dividends are issued. Any changes in shareholding could lead to forfeiting ICs. This is why you should always consult your accountant before adjusting shareholdings.

What’s Next?

We hope this article helps you the tax and administration implications of declaring and receiving a dividend. 

If you need further assistance, please get in touch. Business Like NZ has been providing professional, yet affordable tax and business advice to the Auckland region and beyond for years!