How do dividends work in a small business and limited company?
Any company that makes a profit is entitled to pay a dividend to its shareholders. At Approved Accounting, we’re often asked about how dividends work for limited companies and what the benefits of issuing dividends are for small business owners.
A limited company may choose to pay dividends from its profits after tax as often as it wishes. Small business dividends can prove the most tax efficient way for limited company directors to pay themselves, as they are subject to a dividend allowance and are taxed at a lower rate than salaried income.
If you need advice on how your limited company should pay dividends or assistance with your personal tax affairs, the the team at Approved Accounting can help. To find out more about our broad range of accounting services or for an online quote, please get in touch.
What are dividends?
A dividend is the way that a share of a company’s profits is distributed to its shareholders. The total dividend pot is the company’s net profits, i.e. after business expenses and tax payable.
Cash dividends are most common, but dividends can be paid in the form of assets or further share capital, known as stock dividends.
How much profit does a company need to make to pay dividends?
A company MUST be making a profit after Corporation Tax in order to pay their shareholders a dividend. If a dividend is paid by a loss making company, it is deemed unlawful.
If a limited company is loss making, it is possible to reduce its share capital (i.e. cancel shares) to create a distributable reserve in order to pay a dividend.
Company’s should be cautious over this approach, as a reduction in capital could be subject to tax. It is a complex route and so the advice of a tax expert is highly recommended.
How much do shareholders receive in dividend payments?
The level of dividends paid to shareholders is proportionate to the shares owned. Some companies have different classes of shares, which may afford certain shareholders enhanced dividends and other benefits.
The company directors will usually confirm the rate at which dividends are paid. The total amount of dividends paid can be reduced by shareholder agreement, but not exceeded.
How often can a limited companies pay dividends?
Large companies usually pay a dividend to shareholders once or twice a year.
For a limited company, the dividend payment schedule is detailed in their Articles of Association, i.e. the written rules about how the company is run, agreed by the directors and shareholders.
A limited company is likely to pay dividends more frequently, especially if the directors are shareholders themselves.
There is no limit as to how often or how much a company can pay in dividends and some directors choose to take a dividend monthly to become more tax efficient.
How do you make a dividend payment?
In order to generate a dividend payment a formal directors meeting is usually called.
When the company pays the shareholders, they must issue them a dividend voucher showing the company name, the date and the dividend amount.
This is considered a receipt for the recipient’s tax purposes and must also be kept on in the company’s records.
Do dividend payments affect a company’s Corporation Tax bill?
Companies do not pay tax on dividends, rather, the dividend pot is calculated after Corporation Tax has been deducted.
Therefore, dividend payments do not have any effect on the amount of Corporation Tax a company owes.
The individuals that receive dividends are required to pay tax on their dividend income, over a their set dividend allowance.
Do you need to pay tax on dividends?
All individuals in the UK must pay income tax on earnings that exceed the tax-free personal allowance threshold of £12,570.
This includes dividend income, so shareholders must declare dividends to HMRC as part of their annual tax return.
The first £2,000 of dividend payments received is subject to the tax-free dividend allowance.
After that, tax is due commensurate with your tax band.
| Tax band | Income tax Rate | Dividend Tax Rate |
| Basic rate tax band | 20% | 8.75% |
| Higher rate tax band | 40% | 33.75% |
| Additional rate tax band | 45% | 39.35% |
NOTE – Updated in line with the latest announcement by the Chancellor on 17 October 2022.
Is taking a salary or dividends more valuable?
Some company directors choose to remunerate themselves with both a salary and dividends, to save money on their personal tax bill.
This tax efficient method has become an even more attractive option following the government’s mini-budget, with the dividend tax rate set to fall in April 2023.
Approved Accounting are trusted tax specialists
At Approved Accounting we provide accounting services and tax advice to many SMEs. If your limited company is struggling with the weight of accounting tasks, we can help.
Not only can we take the burden of tax returns off of your hands and keep you compliant with HM Revenue, it’s possible that we can actively save you money by becoming more tax efficient.
To start a conversation about your tax and accounting needs, please get in touch.
Conclusion
Dividends are payments made to shareholders from a company’s profits after business expenses and tax.
There is no limited to how often a limited company can issue dividends, which can be as frequently as monthly, if required.
The company must issue a dividend voucher to accompany all payments, as dividends are taxable.
The rate of tax on dividends is less than income tax, making a combination of salary plus dividends an attractive option to small business owners.
UPDATED 17 October 2022
Article updated to reflect the Chancellor’s latest revisions to the mini-budget of 3 October 2022, that is, the changes from the 2023/4 tax year:
- 45% higher rate of income tax to remain
- Corporation Tax to be increased to 25%
- Basic rate of income tax to remain at 20%
- 1.25% dividend tax reduction scrapped
