Dividends are payments that a company makes to its shareholders from its profits. When a limited company earns more than it spends, the surplus belongs to the company. The directors can then decide to distribute some or all of those profits to the shareholders as dividends.
- Dividends are returns on owning shares, distinct from salary, and are a key way limited companies reward shareholders and extract income tax-efficiently.
- They can only be paid from distributable profits; unlawful dividends risk personal liability for directors and repayment obligations for shareholders.
- The process requires a board resolution, dividend vouchers, and proper records to prove legality and support HMRC and personal tax reporting.
- Different share classes and using a mix of salary and dividends allow tailored, often more tax-efficient income for directors and shareholders.
How Dividends Work in a Limited Company
A dividend is a return on investment. When someone buys or holds shares in a company, they become a part-owner. Dividends are the mechanism by which that ownership translates into financial reward. Only companies with share capital can pay dividends. This means that private companies limited by shares and public limited companies (PLCs) can issue dividends. Companies limited by guarantee, which have no share capital, cannot.
The amount each shareholder receives depends on the number and type of shares they hold. If a company has four shareholders, each owning 25% of the ordinary shares, and the company declares a £40,000 dividend, each shareholder receives £10,000.
Dividends are distinct from salaries. A salary is a fixed payment for work performed and is subject to income tax and National Insurance contributions. Dividends are a distribution of profit and are taxed differently, which is one reason they feature so prominently in how directors of owner-managed companies choose to pay themselves.
The Legal Rules on Paying Dividends
A company can only pay dividends from distributable profits. This is a strict legal requirement under Section 830 of the Companies Act 2006. Distributable profits are defined as the company’s accumulated realised profits, less its accumulated realised losses, that have not already been distributed or capitalised.
In plain terms, a company must have sufficient retained profit, after paying corporation tax and all other obligations, before it can declare a dividend. If the company has no profits, or if its losses exceed its profits, dividends cannot legally be paid.
Paying a dividend without sufficient distributable profits is known as an unlawful dividend. Directors who authorise unlawful dividends can be held personally liable for repayment. Shareholders who receive an unlawful dividend knowing (or having reasonable grounds to know) that it was unlawful may also be required to return it. This is why maintaining accurate and up-to-date management accounts is essential. Before declaring any dividend, the directors should confirm that the company’s financial position supports the payment.
How Dividends Are Declared and Paid
The process for declaring and paying dividends involves several steps, each of which should be properly documented.
- The directors hold a board meeting and pass a resolution to declare a dividend. The resolution should specify the total amount to be distributed, the amount per share, and the date of payment. Minutes of this meeting must be kept as part of the company’s records.
- A dividend voucher is then issued to each shareholder. The voucher should include the company name, the date of the dividend, the name of the shareholder, and the amount paid. These vouchers serve as the formal record of the payment and are needed when shareholders complete their personal tax returns.
- The payment itself is usually made by bank transfer into each shareholder’s personal account. Some companies pay dividends by cheque, though this is less common today.
| Step | Description |
|---|---|
|
Board resolution |
Directors agree on the dividend amount, per-share rate, and payment date |
|
Dividend voucher |
Formal record issued to each shareholder showing the amount paid |
|
Payment |
Funds transferred to shareholders, typically by bank transfer |
Interim Dividends and Final Dividends
Dividends can be paid at different points during the financial year. The two main types are interim dividends and final dividends. Interim dividends are declared and paid during the company’s financial year, based on the company’s current trading performance as shown in management accounts. There is no limit on the number of interim dividends a company can pay in a single year. Many owner-managed companies pay monthly or quarterly interim dividends to provide shareholders with regular income.
Final dividends are declared after the end of the financial year, once the annual accounts have been prepared. The directors recommend the final dividend, and the shareholders approve it at a general meeting or by written resolution. Shareholders can approve or reduce the recommended amount, but they cannot increase it.
In practice, smaller companies and owner-managed businesses tend to rely on interim dividends for regular income. Final dividends are more common in larger companies with formal annual reporting cycles.
How Dividends Are Taxed
Dividends are subject to personal income tax, but the rates are lower than those applied to employment income. The UK tax system provides a dividend allowance, which is the amount of dividend income you can receive each year without paying tax on it. Dividend income within the annual allowance is tax-free, regardless of which income tax band you fall into. Dividends falling within your personal allowance are also free of income tax. The government sets the dividend allowance each tax year, and it has changed several times in recent years.
Once your total income exceeds these thresholds, dividend income is taxed at three rates: basic rate, higher rate, and additional rate. Each of these rates is lower than the equivalent income tax rate on employment income, which is why many directors of owner-managed companies take a combination of a low salary and dividends to reduce their overall tax liability. It is important as a company shareholder to keep up to date with the latest UK dividend tax rates and allowances.
Salary vs Dividends for Company Directors
It is important to understand how to pay yourself a salary or dividends as a director so that you can make the best decision for your needs. Directors of owner-managed limited companies have flexibility in how they pay themselves. The two main options are salary and dividends, and most directors use a combination of both. A common approach is to pay a salary up to the National Insurance primary threshold. This keeps the salary within the personal allowance, meaning no income tax is due, and minimises National Insurance contributions.
Above this amount, the director takes additional income as dividends. Because dividend tax rates are lower than income tax rates and no National Insurance is payable on dividends, this approach can reduce the total tax paid compared with taking the same amount entirely as salary. However, dividends can only be paid from profits. A director cannot declare dividends if the company has not earned enough profit to cover them. This is a fundamental constraint that separates dividends from salary.
Taking a salary, even a modest one, also has benefits. It builds up entitlement to the State Pension and contributes to a National Insurance record. A salary is also a tax-deductible expense for the company, reducing its corporation tax bill. Dividends, by contrast, are paid from post-tax profits and are not deductible.
Not all shares carry the same dividend rights. Companies can create different classes of shares, each with different entitlements. Ordinary shares are the most common type. All ordinary shares of the same class carry equal dividend rights. If the company declares a dividend, every holder of ordinary shares receives the same amount per share.
Alphabet shares are a variation of ordinary shares. A company creates separate classes labelled A, B, C, and so on. Each class can be assigned a different dividend rate. This allows directors to distribute profits unevenly among shareholders if needed. Alphabet shares are often used in family businesses or companies with multiple shareholders who have different roles and contributions.
Preference shares carry a fixed dividend rate that is paid before any dividends are distributed to ordinary shareholders. If the company’s profits are limited, preference shareholders are paid first. Once their entitlement is met, any remaining profit can be distributed to ordinary shareholders.
How to Withdraw Funds from a Limited Company
Dividends are one of several ways to withdraw funds from a limited company. Other legitimate methods include taking a salary, repaying a director’s loan, claiming reimbursement for business expenses, and making pension contributions from the company. Each method has different tax implications. A salary is tax-deductible for the company but subject to income tax and National Insurance. Dividends are not tax-deductible for the company but are taxed at lower personal rates. Pension contributions can be highly tax-efficient but tie up the funds until retirement. The most effective approach usually involves a combination of these methods, tailored to the director’s personal circumstances and the company’s financial position.
The Records a Company Must Keep When Paying Dividends
Keeping records protects directors from personal liability and ensures the company meets its obligations under the Companies Act 2006. Your company should retain minutes of the board meeting at which the dividend was declared. These minutes should record the date, the amount per share, the total distribution, and the names of the directors who voted in favour.
A dividend voucher must be issued to each shareholder for every dividend payment. The voucher should show the company name, the date, the shareholder’s name, the number of shares held, the dividend rate per share, and the total amount paid. Shareholders need these vouchers to complete their Self Assessment tax returns.
The company’s management accounts or financial records should also demonstrate that sufficient distributable profits existed at the time each dividend was declared. If HMRC queries a dividend payment, the directors will need to show that the payment was lawful.
Final Words
Dividends are a fundamental part of how limited companies distribute profits to their shareholders. They offer a tax-efficient method of extracting income from a business, particularly when combined with a modest salary. The legal requirements around distributable profits, proper documentation, and accurate record-keeping are straightforward to follow but must not be overlooked.
