In today’s accounting tutorial article, we will look at the journal entry for dealing with withholding tax when a dividend is paid and received. Ensuring that this direct tax is accounted for correctly is essential for both the entity paying the dividend, acting effectively as a tax agent for the tax authority and the entity receiving the funds – ensuring they meet their tax obligations.
We usually provide the quick answer for those in a hurry, but there is a little more to it for this topic. However, the journal entries are set out below, so just scroll down.
What are Dividends and Withholding Tax?
Dividends
The payment of dividends relates to the distribution of profits to shareholders. Dividends are paid from earnings after income tax at an amount determined by the Board of Directors in cash or shares.
Although this article will not get into imputation credits (also known as franking credits) and how they offset withholding tax, imputation systems provide an effective means of avoiding double taxation. For example, when a company pays dividends, it is doing so from after-tax profits. However, when the shareholders receive those dividends, they then have to pay income tax again. I still find this an incredible way of treating this income in some tax jurisdictions, like the United Kingdom, but there you go.
Withholding Tax?
Accordingly, most countries in the world have a withholding tax system. The most common forms of income this system is applied to are wages and salaries, interest and dividends.
Therefore in acting as a tax agent for the applicable tax authority, the payer deducts a set percentage from the payment 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 offset the income generated tax liability.
Journal Entry for Dividend Withholding Tax
Now that we have covered some of the theories 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
Journal Entry One – Dividend Creation
The journal entry that creates the dividend liability and withholding tax is:
| Date | Account Name | Debit | Credit |
|---|---|---|---|
| March 31 | Dividends | 50,000 | |
| Withholding Tax | 10,000 | ||
| | Dividends Payable | | 40,000 |
The debit to dividends is a distribution of profits or retained earnings – and is the gross figure (which includes the withholding tax is 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 to the tax authority. Subsequently, that obligation is paid by ABC Ltd from the deducted funds. The declaration and payment of dividends create a taxable event for which it is responsible for the charging, collecting, and paying the withholding tax. Lastly, the credit to dividends payable of $40,000 reflects what will be paid out to shareholders – which in our case will be cash.
Journal Entry Two – Dividend Payment
Finally, this brings us to the second journal entry, paying dividends to shareholders and withholding tax to the tax authority. That entry is provided below (we have assumed declaration and payment all took place on the same day, which of course, may not be the case).
| Date | Account Name | Debit | Credit |
|---|---|---|---|
| March 31 | Dividends Payable | 40,000 | |
| Withholding Tax | 10,000 | ||
| | Bank | | 50,000 |
As a result, 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 the bank of $50,000 is the combined payment.
Conclusion
And that concludes our 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.