What are Dividends and Tax on Dividends?

As a limited company director, you have greater flexibility to work around the tax system, and are able to implement tax optimisation strategies not available via other business structures.

One of these ways is to draw dividends from your company, as opposed to receiving a salary; doing so can help to reduce your tax bill.

If you're newly self-employed, this can be rather confusing.

You might be wondering: How can dividends help reduce my tax bill, and what taxes do I need to pay on them? Are there additional considerations I need to keep in mind?

These are the questions we'll be answering below:

A dividend is a payment of profit that a limited company distributes to its shareholders.

This is the money remaining after all business expenses and liabilities, as well as outstanding taxes (including VAT and Corporation Tax) have been paid off. 

Dividends must be distributed according to the percentage of ownership of each shareholder. Here's an example: if you own 50% of your company's shares, you will receive dividends amounting to 50% of the retained profit. 

There are two common types of dividends you need to know about: final and interim dividends.

Final dividends are dividends declared at the end of a company's financial year, usually after the company's annual financial statements are prepared and audited. These dividends are based on the profits earned during the entire financial year and are proposed by the board of directors. Final dividends are then approved by the shareholders at the company's annual general meeting (AGM). Once approved, the company pays these dividends to its shareholders.

Interim dividends are dividend payments that are made before a business’ year-end financial statements are released. As such, it is paid out from a company’s retained earnings - not current earnings. The board of directors can propose interim dividends based on the company's interim financial statements, which provide a snapshot of the company's financial performance up to a certain date in the financial year. The shareholders also need to approve interim dividends, typically through a resolution passed at a board meeting. Interim dividends can be paid at any time across the year, and are typically a smaller payout compared to final dividend.

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Dividends are a crucial aspect of a company's financial operations, allowing for the distribution of profits to shareholders. However, the process of declaring, documenting, and disbursing dividends involves significant paperwork and regulatory compliance.

Key Documents Involved

1. Board Resolutions

The board of directors passes resolutions to propose, approve, and declare dividends. These resolutions outline the amount of dividends, the payment date, and other pertinent details. They are a fundamental part of dividend paperwork, demonstrating the legal intent to distribute profits.

2. Dividend Vouchers

A dividend voucher is a document that provides shareholders with information about their dividend payments. It includes the company name, shareholder's name, dividend amount, and payment date. This document is crucial for tax reporting and acts as evidence of dividend receipt.

3. Dividend Registers

Dividend registers record details of each dividend payment made by the company. It includes shareholder names, dividend amounts, dates of payment, and any other relevant information. This register is essential for tracking dividend payments accurately.

4. Tax Forms

Various tax forms need to be completed and submitted to the tax authorities, detailing dividend payments made. These forms ensure that proper tax deductions and reporting are carried out in compliance with tax laws.

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Taking Dividends from a Limited Company

1. Ensure Availability of Profits

Before declaring dividends, confirm that the company has distributable profits. These are the profits available for distribution after deducting taxes, expenses, and any retained earnings from previous years.

2. Review Company's Articles of Association

Check the company's articles of association for any specific provisions regarding dividend distribution. The articles may outline conditions and procedures for dividend declaration.

3. Hold a Board Meeting

Convene a meeting of the board of directors to propose and approve the dividend declaration. During the meeting:

• Review the financial statements to verify available profits for distribution.
• Propose the dividend amount per share and the payment date.
• Vote and approve the dividend declaration.

4. Prepare Dividend Vouchers

After board approval, prepare dividend vouchers for each shareholder. The vouchers should include details such as shareholder name, dividend amount, payment date, and the company's name.

5. Record Dividends in Company Records

Record the dividend declaration in the company's financial records and dividend register. The register should contain details like the names of shareholders, dividend amount, and date of payment.

6. Ensure Tax Compliance

• Dividend Allowance: Ensure that the total dividends received by an individual shareholder do not exceed the annual dividend allowance. As of 2023/24, the allowance is £1,000.
• Tax Rates: Understand the tax rates for dividends based on the shareholder's income tax band (basic, higher, or additional rate).
• Tax Payment: Shareholders are responsible for calculating and paying any tax due on the dividends they receive.

7. Distribute Dividends

On the declared payment date, transfer the dividend amounts to the shareholders' bank accounts as specified in the dividend vouchers.

8. Issue Dividend Payment Confirmation

Send confirmation of the dividend payment to each shareholder, detailing the amount paid and the payment date.

9. Retain Documentation

Retain copies of all dividend vouchers, board meeting minutes, and dividend registers for record-keeping and potential future audits.

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How often can I pay myself dividends?

You can draw dividends from your company at any frequency across the year, as long as your company has sufficient distributable profits. Payments are typically made on a monthly or quarterly basis. 

A common concern among contractors we work with is that HMRC may regard frequent payments as disguised salary. To keep in the good books of HMRC, ensure that you keep clear records and have the right paperwork in place.

Keep your salary and dividend payments separate, as this leaves a clear audit trail. In doing so, you’ll be able to prove that nothing is amiss, and that you’ve gone by the books should HMRC decide to launch a tax enquiry.

Do note that dividends can’t be drawn from contracts that fall within IR35. For further information on off-payroll working rules and what it means for contractors, refer to our comprehensive guide on IR35.

What else can I do with dividends? 

You may consider paying dividends into a pension fund, ISA or to family members.

You’ll need to weigh out the pros and cons of each option, and consider the tax and legal implications. This can be complex, and is a decision that is best made after consulting an accountant.

Key dates you need to know

Dividend declaration date: 
The date at which details of the dividend payment - such as the dividend amount, the date of record and payment date - are announced by a company’s board of directors. 

Record date: 
A cut-off day that is used to determine who is on the share register, and as such qualifies to receive dividend payouts.

In other words, in order to receive the dividend, an individual has to be a shareholder by the record date. The record date typically falls on a Friday.

Ex-dividend date: 
Also referred to as the ex-date, the ex-dividend date refers to the last day on which an individual must own shares in order to qualify for the upcoming dividend.

If an investor buys shares on or after the ex-dividend date, the payout will go to the seller. The ex-dividend date typically falls on a Thursday, as it is usually set one working day before the record date. 

Payment date:
The date at which dividends are paid out to shareholders.

Dividends can't be paid out if a company is losing money

Dividends can only be paid on profits that a company has earned during the year, or from accumulated profits from previous years. On the other hand, salaries can be paid out even when a company has made a loss. 

Paying a dividend doesn't reduce your company's corporation tax bill

Companies pay Corporation Tax on its profits before dividends are distributed, so paying a dividend doesn't affect your company's corporation tax bill.

On the other hand, salaries are considered as business expenses. These reduce your profit, and subsequently your Corporation Tax.

Creating different classes of shares can be an option worth exploring

Does your company have working and non-working partners?

Creating different classes of shares may be an option you might want to explore, so that both types of partners don't wind up receiving the same dividend rate. 

Timing is key 

In general, companies distribute dividends every quarter or half year.

There aren't any hard and fast rules when it comes to how often dividends are paid out-and this is something your need to consider carefully.

That's because: 

• It can have an impact on the amount of tax you pay: Dividends can be a way for you to balance out your profits from one year to another, so you can avoid being put into a higher tax bracket. If your profits are £55,000 in the first year and £10,000 in the second year, you can declare a lower dividend for the first year so that you pay the basic rate for both years-rather than paying the higher rate for the first year.

• It can have an impact on your HMRC deadlines: Income tax on dividends are due in January after the tax year (running 6th April - 5th April) in which the dividend was distributed. This means that tax on a dividend received in February 2020 will be due in January 2021. If the dividend was paid out on May 2020, the tax will be due in January 2022. 
  

Your personal pension can be affected

Receiving income as dividends (rather than a salary) can help reduce your tax load.

Yet, it's important to keep in mind that your personal pension will be affected, as getting a salary increases contributions that can be paid into your personal pension. 

We recommend checking in with your accountant about minimum salary requirements that may be imposed if you want to make contributions to a personal or executive pension plan. You may also want to discuss whether setting up a company pension scheme is an option you should consider. 

Business owners typically pay themselves through a blend of salary and dividends, as this is a more tax efficient way to operate.

That's because neither the company, nor you (as an employee) are required to pay National Insurance Contributions on dividends. You are required to pay tax on dividends though— and we'll explain more about this in a separate guide on dividend taxes, rates and allowances.

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