A dividend tax is a tax imposed by a jurisdiction on dividends paid by a corporation to its shareholders (stockholders). The primary tax liability is that of the shareholder, though a tax obligation may also be imposed on the corporation in the form of a withholding tax. In some cases the withholding tax may be the extent of the tax liability in relation to the dividend. A dividend tax is in addition to any tax imposed directly on the corporation on its profits. Some jurisdictions do not tax dividends.
To avoid a dividend tax being levied, a corporation may distribute surplus funds to shareholders by way of a share buy-back. These, however, are normally treated as capital gains, but may offer tax benefits when the tax rate on capital gains is lower than the tax rate on dividends. Another potential strategy is for a corporation not to distribute surplus funds to shareholders, who benefit from an increase in the value of their shareholding. These may also be subject to capital gain rules. Some private companies may transfer funds to controlling shareholders by way of loans, whether interest-bearing or not, instead of by way of a formal dividend, but many jurisdictions have rules that tax the practice as a dividend for tax purposes, called a "deemed dividend".Australian Taxation Office, "Deemed dividends from private companies"
History
In the beginning of income tax history, dividends paid to shareholders were exempt from taxation, as such tax was considered a form of double taxation on money earned by companies and subject to corporate tax.
Currently, in most jurisdictions, dividends from corporations are treated as a type of income and taxed accordingly at the individual level. Many jurisdictions have adopted special treatment of dividends, imposing a separate rate on dividends to wage income or capital gains.
Here is a brief history of dividend taxation:
17th century: The first dividend taxes were imposed in the 17th century in the Netherlands and England. 19th century: Dividend taxes became more common in the 19th century, as more countries adopted income taxes. United States: Dividend taxes were first imposed in the United States in 1913, with the passage of the 16th Amendment to the U.S. Constitution. 1936–1939: During the Great Depression, dividends were taxed at an individual's income tax rate. 1954: The Tax Reform Act of 1954 created a separate rate for dividends, which was lower than the individual income tax rate. 1981: The Economic Recovery Tax Act of 1981 further reduced the tax rate on dividends. 2003: The Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced the tax rate on dividends to 15% for most investors. 2013: The American Taxpayer Relief Act of 2012 (ATRA) increased the tax rate on dividends to 20% for taxpayers in the top income tax bracket.
In the United States, the Revenue Act of 1913, authorized via the 16th Amendment, created a federal personal income tax of 1% with additional surtaxes of 1–5%, and exempted dividends from the general income tax but not the surtaxes which applied above the $20,000 level. This was to avoid the double taxation of income as there was a 1% corporate tax as well. After 1936, dividends were again subject to the ordinary income tax, but from 1954 to 1983 there were various exemptions and credits, taxing dividends at a lower rate. Following this, there was an eighteen-year period (1985–2003) in which dividends were fully taxed at an individual's income tax bracket. During this period, the top tax bracket ranged between 28% and 50%. However, in 2003 former president George W. Bush enacted the Jobs and Growth Tax Relief Reconciliation Act of 2003, which changed tax rates significantly. These 2003 tax cuts created a new category of qualified dividend that was taxed at the lower long-term capital gains rate instead of the ordinary income rate.
The current tax rate on dividends in the United States is 20% for taxpayers in the top income tax bracket, and 15% for taxpayers in the lower income tax brackets. There are also special rules for qualified dividends, which are dividends that are paid by companies that have met certain requirements. Qualified dividends are taxed at a lower rate of 0%, 15%, or 20%, depending on the taxpayer's income.
The history of dividend taxation outside the US is just as varied as it is in the US. Here is a brief overview of dividend taxation in some major countries:
United Kingdom: In the financial year beginning 6 April 2024, dividends in the UK are taxed at a rate of 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers, and 39.35% for additional rate taxpayers. There is also a dividend allowance of £500 per year, which means that dividends up to £500 are tax-free. The rates have increased and the allowance reduced since 2022. Canada: Dividends in Canada are taxed at a rate of 50% for non-residents, and 15% for residents. There is also a dividend tax credit that can be used to reduce the amount of tax that is owed on dividends. Australia: Dividends in Australia are taxed at a rate of 30% for non-residents, and 15% for residents. There is also a dividend imputation system that allows shareholders to claim a credit for the taxes that the company has already paid on its profits. Japan: Dividends in Japan are taxed at a rate of 20% for non-residents, and 15% for residents. There is also a dividend exemption system that allows shareholders to exempt dividends from tax if they meet certain conditions. Germany: Dividends in Germany are taxed at a rate of 25% for non-residents, and 26.375% for residents. There is also a dividend tax credit that can be used to reduce the amount of tax that is owed on dividends.
Collection
In many jurisdictions, companies are subject to withhold obligations of a prescribed rate, paying this to the national revenue authorities and paying to shareholders only the balance of the dividend.
Debate
Taxation of dividends is controversial, based on the issues of double taxation. Depending on the jurisdiction, dividends may be treated as "unearned income" (like interest and collected rents) and thus liable for income tax.
Arguments in favor A corporation is a legal entity separate from its shareholders with a "life" of its own. As a separate entity, a corporation has the right to use public goods as an individual does, and is therefore obligated to help pay for the public goods through taxes.Double Taxation of Dividends: Is the Question Resolved? By Novella Clevenger and Ken Pfannenstiel published in New Accountant magazine.
Professor Confidence W. Amadi of West Georgia University has argued:
Once it is established that a corporation is, for all important purposes, a separate legal entity, the issue becomes how transfers from one legal entity (corporations) to another legal entity (shareholders) should be taxed, not whether the money should be taxed. It can be argued that it is unfair and economically unproductive to tax income generated through active work at a higher rate than income generated through less active means.
A 2022 study in the American Economic Review found that a substantial increase in dividend tax rates in France led to reduced dividend payments by firms and greater re-investment of profits back into the firms. The study also found that the dividend taxes did not contribute to a misallocation of capital, but may instead have reduced a capital misallocation. The study was retracted after several inconsistencies in the data were pointed out by other researchers, some arguing that the alterations affected the results of the paper. The authors disputed that the results would have been altered.
Arguments against Critics, such as the Cato Institute, argue that a dividend tax is an unfair "double taxation". Cato's position is:
Besides discussed above issues of whether taxing dividends is right and fair, a major issue is tax-induced distortions of economic incentives. For instance, quoting from:Statement by the Members of the President’s Advisory Panel on Federal Tax Reform https://govinfo.library.unt.edu/taxreformpanel/04132005.pdf "Efforts to avoid the double tax on corporate earnings have created a misallocation of investment between the corporate and non-corporate sectors and rapid growth in the use of S corporations, partnerships, and other entities that do not pay corporate income tax."
The taxpayers retain the post-tax income, while the whole pre-tax income, tax including, forms the national resources. A mismatch between the actual income as perceived by taxpayers and the taxable income distorts economic incentives by providing tempting ways to boost their difference. It promotes tax planning to maximize the post-tax income to the detriment of the pre-tax one: "We have seen how preferences in the tax code cause taxpayers to devote more resources to tax-advantaged investments and activities at the expense of other more productive alternatives."
Shareholders control corporations and bear their tax burdens: "Economists at both the Treasury Department and the Congressional Budget Office assume that the burden of the corporate income tax is borne entirely by owners of capital."Proposals to Fix America’s Tax System. Connie Mack, III (Chairman), John Breaux (Vice-Chairman), Jeffrey F. Kupfer (Executive Director), Members: William E. Frenzel, Elizabeth Garrett, Edward P. Lazear, Timothy J. Muris, James M. Poterba, Charles O. Rossotti, Liz Ann Sonders. https://www.treasury.gov/resource-center/tax-policy/Documents/Report-Fix-Tax-System-2005.pdf (They also note that, over time, capital flight may shift part of the combined tax burden onto employees and consumers.) Both corporate tax and personal taxes on dividends and capital gains in combination reduce shareholders comprehensive incomeR.M.Haig. The Concept of Income. In R.M.Haig(ed). The Federal Income Tax, 1921. which includes the change in their stock portfolio value.
Changes of stock value are hard to legally define and timely tax.L.Levin. Taxation and Valuation. Tax Notes Federal, 164(7):1065-1067, section "Cash Taxes Cannot Avoid Distortion of Incentives" https://www.taxnotes.com/tax-notes-federal/tax-policy/taxation-and-valuation/2019/08/12/29rhnibid. section "Just One Issue in a Broader Scope". Parts of these changes have a legally recognizable source. E.g., cash earned by corporations can be taxed at the corporate level. But there are other "hidden" parts, e.g., when corporations gain valuable patents or see favorable markets shifts. They increase stock values but cannot be legally measured and timely taxed at the corporate level.
These parts can be realized and taxed at the shareholders level when dividends are paid or stock trade yields capital gains. However, when owners take dividends from their shares (or gains from selling them) their cash portfolio grows but the value of their stock portfolio shrinks by the same amount, resulting in no net comprehensive income. Instead, the earlier growth of stock values gets legally recognized and (belatedly) taxed. However, this also includes growth that reflects previously taxed corporate income, resulting in double taxation.Lanfeng Kao & Anlin Chen (2011): Dividend policy and elimination of double taxation of dividends; Asia-Pacific Journal of Financial Studies. 2011