Partner’s Opinion – Nick Walls
Staying on top of retained earnings and dividends is crucial for maintaining your company’s financial health. Retained earnings represent profits that haven’t been distributed to shareholders, but failing to manage these properly can lead to unintended tax consequences, especially with imputation credits.
Why Stay on Top of Dividends from Retained Earnings?
- Efficient Cash Flow Management
Retained earnings give your company flexibility to reinvest or distribute dividends. By managing dividend distributions wisely, you balance rewarding shareholders while maintaining healthy cash flow for business operations and future growth. - Maximising Imputation Credits
In New Zealand, dividends carry imputation credits, which reduce shareholders’ tax on dividend income by offsetting tax the company has already paid. However, the company tax rate (28%) may not cover shareholders’ entire tax obligations, meaning additional tax may apply. - Additional Tax Liabilities
Shareholders often face further tax on dividends. Individual and Trust shareholders in the 39% tax bracket pay an additional 11% tax on their dividends, after imputation credits. The company partially covers this through 5% dividend withholding tax (DWT) paid on behalf, which adds an extra cash cost to the company that impacts financial reserves. Individuals and Trusts (that cannot allocate the income to Beneficiaries) face paying the additional 6% of tax themselves. - Avoiding Breaches of Shareholder Continuity
Imputation credits are tied to shareholder continuity. A significant change in shareholding (more than 34% turnover) can cause your company to lose the ability to use accumulated credits. Regular review of dividend distributions can help avoid breaching these rules, protecting both the company and shareholders from tax complications. - Prevention of Overaccumulation
Accumulating too much in retained earnings can frustrate shareholders expecting dividends. Keeping a proactive dividend policy shows transparent financial management and avoids unnecessary scrutiny. - Planning for Shareholder Exits
If a shareholder is exiting the business, distributing dividends from retained earnings ensures they receive their share of profits. It also helps avoid triggering shareholder continuity breaches, protecting the company’s future imputation credit use, which is an important part of any succession planning.
Managing dividends from retained earnings is essential for good financial stewardship. It ensures shareholders benefit from imputation credits, minimizes unexpected tax liabilities, and keeps cash flow stable. Companies should also plan for the additional cash cost of paying dividend withholding tax, and the implications this might have on shareholders’ personal tax positions. For more advice on dividend and tax planning, contact our team at Leech & Partners.
