Understanding Dividends and Imputation Credits in New Zealand

For New Zealand business owners and investors, understanding how dividends and imputation credits work is crucial for effective tax planning and compliance. This comprehensive guide breaks down the key concepts, calculations, and considerations you need to know.

What Are Dividends and How Do They Work?

Dividends represent a way for companies to distribute profits to their shareholders. When you receive dividends in your bank account, they arrive already having been taxed at the source, similar to bank interest payments. However, the process behind declaring and paying dividends involves several important steps and considerations that company directors must understand.

Prerequisites for Declaring Dividends

Before any company can declare dividends, directors must ensure they meet the solvency test requirements:

1. Liquidity Test: The company must remain able to pay its debts as they fall due
2. Balance Sheet Test: The company’s assets must exceed its liabilities, including any contingent liabilities

These requirements protect creditors and ensure the company maintains financial stability while rewarding shareholders.

Understanding the Tax Implications

The Double Taxation Problem

Dividends create a potential double taxation scenario because they represent income for shareholders but come from the company’s after-tax profits. Without proper mechanisms, this would mean:

• The company pays tax on its profits (28% company tax rate)
• Shareholders pay tax again on the dividend income they receive

How Imputation Credits Solve Double Taxation

New Zealand’s imputation credit system prevents this double taxation by allowing companies to pass on tax credits to shareholders.

What is an Imputation Credit?

Imputation Credits (ICs) represent tax already paid by the company at the 28% rate. These credits are attached to dividends and passed to shareholders, who can use them to offset their personal tax liability.

Dividend Withholding Tax (DWT)

Since dividends are taxed at 33% but imputation credits only cover 28%, there’s a 5% gap that must be addressed. This is where Dividend Withholding Tax comes in:

• DWT Rate: 5% (the difference between 33% dividend tax rate and 28% company tax rate)
• Who Pays: The company pays this additional 5% to Inland Revenue
• Purpose: Ensures shareholders are correctly taxed on the full dividend amount

Once dividends are fully imputed, shareholders can use both the imputation credits and DWT as tax credits to reduce their overall tax liability.

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

Practical Example: Dividend Calculation

Let’s examine how this works with a concrete example:

Company Perspective:

• Company Profit (2024): $200,000
• Company Tax (28%): $56,000
• Net Dividend Available: $144,000
• Additional DWT (5%): $10,000 (paid by company to IRD)

Shareholder Perspective:

• Gross Dividend Received: $200,000
• Less: Company Tax Credit (ICs): -$56,000
• Less: DWT Credit: -$10,000
• Net Cash Received: $134,000

The shareholder receives $134,000 in cash but has $200,000 of taxable income with $66,000 in tax credits to offset their liability.

The Imputation Credit Account (ICA)

Companies must maintain an Imputation Credit Account to track available tax credits. This account records:

Credits (Positive Entries):

• Income tax payments
• Resident Withholding Tax (RWT) paid on interest received
• Previous period credit balances

Debits (Negative Entries):

• Imputation credits attached to dividend payments
• Tax refunds received

Example ICA Movement:

• Opening Balance (April 2024): $4,500
• Add: Income Tax Paid: $56,000
• Add: RWT Paid on Interest: $2,600
• Total Available Credits: $63,100
• Less: ICs Attached to Dividends: -$56,000
• Closing Balance (March 2025): $7,100

Important ICA Rules:

If a company ends the tax year with a debit balance in its ICA, it must pay Inland Revenue the outstanding amount plus a 10% penalty. This makes careful ICA management essential.

Key Planning Considerations

1. The 39% Personal Tax Rate Impact

For high-income earners with total income exceeding $180,000 annually:

• Income above this threshold is taxed at 39%
• Dividends only provide tax credits at 33%
• Result: Additional 6% tax liability on dividend income above the threshold

This creates a tax disadvantage for high-income shareholders receiving significant dividend income.

Learn more: How Much Tax Will I Pay in NZ: Guide to NZ Tax Rates

2. Trust Tax Rate Changes

With trust tax rates potentially reaching 39% for net income exceeding $10,000 (effective from 1 April 2024):

• Trusts receiving dividends may face higher tax rates
• Planning Opportunity: Consider distributing dividends to beneficiaries in lower tax brackets
• This strategy can optimize the overall tax outcome for the trust structure

3. Shareholder Continuity Requirements

To maintain imputation credits, companies must satisfy the shareholder continuity rule:

• Requirement: At least 66% of shareholders must remain the same
• Timeframe: From when the tax was paid until dividends are issued
• Consequence: Failing this test can result in forfeiting imputation credits

Critical Point: Always consult your accountant before making any shareholding changes, as the consequences can be significant and irreversible.

Alternative Distribution Methods

Shareholder Salaries

Instead of dividends, companies can distribute profits through shareholder salaries. This approach:

• Avoids the imputation credit system complexity
• Creates PAYE obligations and ACC levies
• May provide different tax outcomes depending on circumstances

The choice between dividends and salaries should be made after considering all tax implications and compliance requirements.

Read more: Drawings and shareholder current accounts

Best Practices for Dividend and Imputation Credit Planning

1. Regular ICA Monitoring

• Track the ICA balance throughout the year
• Plan dividend payments to avoid debit balances
• Consider timing of tax payments and dividend declarations

2. Tax Rate Optimization

• Review shareholders’ personal tax positions
• Consider the impact of the 39% tax rate
• Evaluate trust structures and beneficiary distributions

3. Compliance Management

• Ensure solvency tests are properly documented
• Maintain accurate dividend registers
• Keep detailed ICA records

4. Professional Advice

Given the complexity of dividend and imputation credit rules, professional accounting advice is essential for:

• Optimal tax planning
• Compliance with all requirements
• Avoiding costly penalties and mistakes

The Last Word on Dividends & Imputation Credits

Understanding dividends and imputation credits is crucial for New Zealand business owners and investors. The system, while complex, provides an effective mechanism to prevent double taxation and can be used strategically for tax planning purposes.

Key takeaways include:

• Dividends must meet solvency tests before declaration
• The imputation credit system prevents double taxation
• Dividend Withholding Tax bridges the gap between company and dividend tax rates
• Shareholder continuity rules must be carefully managed
• High-income earners face additional considerations with the 39% tax rate

The interplay between company tax, personal tax rates, and imputation credits creates numerous planning opportunities but also potential pitfalls. Regular monitoring of your Imputation Credit Account, understanding the tax implications for all shareholders, and maintaining compliance with continuity requirements are essential for successful dividend planning.

Whether you’re a business owner considering dividend payments or an investor receiving dividends, understanding these concepts will help you make informed decisions and optimize your tax position within New Zealand’s tax system. Always consult with qualified tax professionals to ensure your specific circumstances are properly addressed and you remain compliant with all regulatory requirements.