In today’s accounting tutorial article we will be looking at what the journal entry is for dealing with withholding tax when a dividend is being paid and when received. Ensuring that this direct tax is correctly accounted for is important for both the entity paying the dividend, acting effectively as a tax agent for the tax authority, and the entity receiving the funds – ensuring their tax obligations are fully met.
At this point we normally give those in a hurry the quick answer, but there is a little more to it for this. However, the journal entries are set out below so just scroll down.
What are Dividends and Withholding Tax?
Dividends of course only relate to companies as they are distributed to shareholders. Dividends are paid from profits after income tax at an amount determined by the Board of Directors, in the form of cash and / or shares.
In this article we are not going to be get into imputation credits (also known as franking credits) and how they can used to offset withholding tax. Imputation systems provide a means of avoiding the double taxation of dividends; ie, the company pays income tax on its profits and, from this aftertax income, pays dividends to shareholders. Who in turn pay income tax on their receipt of those dividends. I still find this an incredible way of treating this income in some tax jurisdictions, like the United Kingdom … but there you go.
Most countries in the world have a type of withholding tax system. The most common forms of income this system is applied too are wages and salaries, interest and dividends.
Acting as a tax agent for the applicable tax authority, the payer of the income is required by law to deduct a set percentage from the payment to be credited against the payee’s tax liability the taxable event generates. The payee does not receive this tax amount, but it is instead sent to the tax authority to be used to offset the tax liability the income earned generated.
Journal Entry for Dividend Withholding Tax
Now that we have covered some of the theory of withholding payments it’s time to look at an example; we will use our trusty ABC Ltd. The Board has decided to make a $50,000 dividend payment to shareholders. Withholding tax within ABC’s tax jurisdiction is 20 per cent on dividends paid to tax residents (which all of ABC’s shareholders are).
Dividend Payment $50,000 x 20% = $10,000 withholding tax
The journal entry that creates the dividend liability and withholding tax is:
The debit to dividends is a distribution of profits or retained earnings – and is the gross figure (which includes the withholding tax being deducted). It is a debit on the capital side of the accounting equation rather than an expense (that would affect profits). The credit to withholding tax for $10,000 creates an obligation for ABC in that it needs to pay these funds over to the respective tax authority. The declaration and payment of dividends creates a taxable event for which it is responsible for the charging, collection and payment of the withholding tax. And lastly the credit to dividends payable of $40,000 reflects what will actually be paid out to shareholders – which in our case will be cash.
Which brings us to the second journal entry, payment of the dividends to shareholders and withholding tax to the tax authority. That entry is set out below (we have assumed declaration and payment all took place on the same day, which of course may not be the case).
|March 31||Dividends Payable||40,000|||
The debit of $40,000 removes the obligation to shareholders for their dividend payment (net of withholding tax). The $10,000 discharges the tax obligation to the tax authority. And the credit to bank of $50,000 is the combined payment.
That brings us to the end of this short article looking at the withholding tax charged on dividends and the journal entry required to account for this. If you have any questions or comments please get in touch.