How do dividends work?

A dividend is a payment made by a limited company to its shareholders from the company’s available profits. Unlike salaries, dividends are not a business expense and cannot be deducted when calculating the company’s Corporation Tax liability. Before paying a dividend, the company must have sufficient distributable profits. These are the profits available for distribution after taking account of the company’s income, expenses and any previous losses.

If profits are retained rather than distributed, they remain within the company and may be used to support future investment or paid as dividends at a later date, provided sufficient distributable profits are available.

If you’re both a director and shareholder, you may choose to receive income as a combination of salary and dividends. The most appropriate balance will depend on your personal circumstances and the company’s financial position.

A company can only pay dividends if it has sufficient distributable profits available.

Before declaring a dividend, the directors should ensure the company has enough distributable profits to cover the payment and that paying the dividend is in the company’s best interests. They should also consider whether the company will have enough cash to meet its ongoing liabilities, such as suppliers, wages and taxes.

If a dividend is paid when there are insufficient distributable profits, it may be an unlawful dividend. This can have legal and tax consequences for both the company and its shareholders.

If you’re unsure whether your company has sufficient distributable profits, consider seeking advice from a qualified accountant before declaring a dividend.

There are no rules about how often a company can pay dividends. Some companies pay dividends monthly, quarterly or annually, while others only declare dividends when they have sufficient distributable profits.

Before declaring a dividend, the directors should:

• confirm that the company has sufficient distributable profits;
• consider whether the company will still have enough cash to meet its ongoing commitments; and
• record the dividend correctly, including preparing the appropriate company records.

The timing of a dividend may also affect the shareholder’s personal tax position, as dividends are taxed in the tax year in which they are received. If you’re planning to pay significant dividends, it’s worth considering the timing carefully and seeking professional advice if necessary.

You may need to pay tax on dividend income you receive from your company.

Whether you pay tax, and how much you pay, depends on:

• the amount of dividend income you receive during the tax year;
• your total taxable income from all sources; and
• the current dividend tax allowance and rates.

Your dividend income is added to your other taxable income, such as salary, pension or rental income, when determining the rate of tax that applies. This means different parts of your dividend income may be taxed at different rates.

As the dividend tax allowance and tax rates can change, you should always check the latest guidance before calculating your tax liability.

Whenever a company declares a dividend, it should keep appropriate records to support the payment.

Board minutes (or a written resolution): The directors should formally approve the dividend and keep a record of the decision. This is usually done by recording board meeting minutes or a written resolution, depending on how the company makes decisions.

Dividend voucher: A dividend voucher should be provided to each shareholder who receives a dividend. It can be issued electronically if the shareholder has agreed to receive documents in that format.

A dividend voucher should include:

• the company name;
• the shareholder’s name;
• the date the dividend is paid;
• the amount of the dividend; and
• details of the shares to which the dividend relates.

The company should keep copies of the dividend vouchers and board minutes as part of its statutory records. These documents may be needed if HMRC asks for evidence that dividends were declared correctly.

It’s important to follow the correct process when paying dividends.

If a company pays dividends without sufficient distributable profits, or fails to keep appropriate records, the payments may be challenged and could have legal or tax consequences for both the company and its shareholders.

To help avoid problems:

• only pay dividends from distributable profits;
• ensure the directors formally approve the dividend;
• prepare and retain the appropriate records, including board minutes and dividend vouchers; and
• keep accurate accounting records to support the amount of the dividend.

If you’re unsure whether a dividend can be paid or how to record it correctly, consider seeking advice from a qualified accountant before making the payment.