What is a Dividend? A Simple Guide for Business Owners

If you run a limited company, you’ve probably heard the term ‘dividend’ thrown around. But what exactly is a dividend? How do you pay yourself legally without getting into trouble with HMRC? And what happens if you accidentally get it wrong?

This blog will break it all down in simple, jargon-free language so you can confidently manage your company finances.

What is a Dividend?

A dividend is a payment made by a limited company to its shareholders from the company’s post-tax profits. It’s a way of taking money out of your business without it being classed as salary, which means it is taxed differently.

Dividends can only be paid if the company has enough retained profits – this is the money left after paying all business expenses, taxes, and liabilities.

For example:

Your company makes £50,000 profit before tax.

After paying corporation tax (19% or 25%), you have £40,000 left.

If your company doesn’t need all of that to reinvest in the business, you can distribute some of it as dividends to shareholders.

Unlike salaries, dividends are not subject to National Insurance contributions, making them a tax-efficient way to take money from your business.

When Can Dividends Be Paid?

Dividends are not like salaries that are paid at fixed intervals. Instead, they can be paid whenever there are sufficient retained profits available. Some companies pay dividends monthly, quarterly, or annually, while others only issue them when they have a surplus of cash.

Important rules to remember:

• You must have enough retained profit to cover the dividend.
• If your company makes a loss, you cannot pay a dividend.
• Even if there is cash in the bank, you cannot issue dividends if your accounts do not show sufficient profits.
• If you pay yourself a dividend when there aren’t enough retained profits, it is classed as an illegal dividend (more on that later!).

How Are Dividends Declared?

A dividend isn’t just a case of transferring money from your business account to your personal account. There is a process that must be followed to keep everything legal and above board.

Steps to Declare a Dividend:

• Check Your Profits – Ensure your company has sufficient retained profits to pay a dividend.
• Hold a Directors’ Meeting – Even if you are the only director, you need to record in writing that a dividend is being declared.
• Issue a Dividend Voucher – A dividend voucher is a document stating:
  • The company name
  • The date of the dividend payment
  • The name of the shareholder(s) receiving the dividend
  • The amount paid
  • This document should be kept in your company records and a copy given to the shareholder receiving the dividend.
• Make the Payment – Transfer the dividend from your company account to your personal account

Failure to keep this paperwork could cause issues with HMRC, leading to dividends being reclassified as salary (which attracts higher tax and National Insurance).

How Are Dividends Taxed?

Dividends are taxed differently from salaries. The amount of tax you pay depends on how much you receive in dividends and your total income for the year.

For the 2024/25 tax year, the dividend tax rates are:

• £0 – £500 (Dividend Allowance) – Tax-free
• Basic Rate (Up to £50,270 total income) – 8.75%
• Higher Rate (£50,271 – £125,140 total income) – 33.75%
• Additional Rate (Over £125,140 total income) – 39.35%

Unlike salaries, dividends do not have National Insurance contributions deducted. This is why many company directors choose to take a small salary (up to the tax-free personal allowance) and the rest as dividends – it’s more tax-efficient!

What Happens If a Dividend is Illegal?

An illegal dividend (also called an ultra vires dividend) happens when a company pays a dividend without having enough retained profit. This could be an innocent mistake, but it has serious consequences.

An illegal dividend must be repaid by the shareholder or reclassified as a director’s loan.

Here’s what can happen:

• If reclassified as a loan – It must be repaid within 9 months of the end of the company’s financial year, or the company will owe extra corporation tax (called S455 tax).
• If HMRC reclassifies it as salary – You may have to pay extra income tax and National Insurance.
• If the company goes insolvent – Directors may be held personally liable for repaying illegal dividends.

To avoid this, always check your retained profits before paying a dividend and keep proper records.

Final Thoughts: Keeping Dividends Simple & Legal

Dividends can be a great way to take money out of your business tax-efficiently, but only if done correctly.

Key Takeaways:

Only pay dividends from retained profits.

Keep proper paperwork, including board meeting minutes and dividend vouchers.

Understand the tax implications and plan accordingly.

Avoid illegal dividends – they can cause serious financial headaches!

If you’re unsure whether your company has enough profit to declare a dividend, it’s always best to check with an accountant. A little advice now can save you from a costly mistake later!

Need help managing your dividends or understanding your company’s finances? Get in touch, and let’s make sure your business stays compliant and profitable!