What are dividends and how do they work in the UK?

Dividends enable limited companies to distribute profits among their shareholders while offering tax-efficient compensation for company directors. This article, written by Simon Laurie and I, will explore the complexities surrounding dividends and what limited companies need to know. 

What is a dividend? 

Simply put, dividends are payments made by a company to its shareholders. Dividends provide limited companies with an effective way to withdraw funds while providing shareholders with regular income. However, dividends can only be issued if the company has generated sufficient profits after all expenses and tax responsibilities are met and doesn’t exceed its profits from both the current and previous years. The remaining balance specifically allocated for dividend payments is known as ‘distributable profits’.  

Learn more: How do UK companies pay dividends to their shareholders?

Final vs interim dividends

Dividends are classified as either ‘final’ or ‘interim’ dividends.

A final dividend is declared in respect of a specific accounting period and is approved by shareholders, usually following a recommendation by the directors, either at a shareholder meeting or, for private limited companies, by way of a written resolution.

An interim dividend is paid in respect of part of an accounting period and can be declared at any time. Interim dividends can usually be approved by the directors alone.

Due to their flexibility, most dividends for private companies are declared and paid as interim dividends.

What is the dividend amount, and how is it determined? 

The dividend amount refers to a sum or the value of shares the company’s shareholders receive in proportion to their ownership stake. The board of directors will analyse the company’s relevant financial data, including management and accounts, to determine this figure. They should also check their articles for any special provisions and consider the company’s cash requirements and future business plans.

A company’s profits available for distribution are its ‘accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated realised losses, so far as not previously written off in a reduction or reorganisation of capital.’  Care should be taken to ensure dividends are only made from distributable profits. For example, if a business generates a post-tax profit of £16,000 and has unused profits of £4,500 from previous years, this means that £20,500 is available for dividend distribution.

When a dividend is approved, a record date is agreed – and it is the shareholders on the register on the record date that are entitled to the dividend.

Dividends are declared as an amount payable per share (on a certain share class) – so the amount paid to each shareholder is in proportion to the shares held.

When determining the dividend amount, companies should look to retain a portion of their profits to address any future uncertainties or reinvest in the business. Another reason why companies might want to retain a portion of their profits is that from a credit rating perspective, lenders would like to see net assets (retained profits) on the balance sheet growing, rather than depleting or being fully utilised each year. As the balance sheet is always on public record, it is good practice to show an improved position each year in the retained profits as this helps to enhance the perceived health of the entity.

How are dividends declared, recorded and paid?  

Before a limited company can distribute dividends, it is necessary for the directors to officially ‘declare a dividend’ during a board meeting. This process is mandatory even if there’s just one director in the company. It should then be recorded in the meeting’s minutes. Dividends are not tied to the year-end and, therefore, can be declared at any time of the year and on multiple occasions across the year. Usually, only if the dividend is being declared as a Final Divided will an additional shareholder meeting or shareholder resolution be required.

A dividend statement should also be prepared for each shareholder showing the shareholder’s name, the date of payment, the number and class of shares on which the dividend is paid and the dividend amount. A copy of the statement should be given to the shareholder for their tax records.

Tax on dividends

There are two significant benefits of dividends. They are generally not taxable in the hands of a company (subject to some exceptions). Secondly, individuals can earn up to £500 in tax-free dividends in 2024/25 and 2025/26. Beyond these thresholds, the tax on dividends depends on the individual’s income tax bracket, either 8.75% for basic rate, 33.75% for higher rate or 39.35% for an additional rate taxpayer.

Salary vs dividends

Individuals who are a director and shareholder of a limited company may wish to pay themselves a combination of salary and dividends.

By receiving a small salary up to ‘lower earnings limit’ of £6,500 for 2025/2026, this would  ensure they retain state benefits, which are dependent on their National Insurance Contributions. Then, individuals can utilise the lower tax rates applicable to dividends. Please see here for more information.

Unlawful dividends, insolvency and legal consequences 

Limited companies must not declare and distribute dividends if insufficient funds are available in retained profits. This is a crucial legal requirement for issuing dividends. These unlawful dividends can lead to significant penalties or additional regulatory measures imposed on the company. Other types of unlawful dividends include when HMRC determines a dividend to be a salary, requiring directors to pay National Insurance Contributions (NIC) and tax.

Even when a company faces insolvency, it may still be penalised for unlawful dividends. Liquidators will scrutinise the firm’s transactions, including dividends, before insolvency to identify any illegal transactions. If they identify any unlawful dividends, shareholders are not legally obliged to repay them; however, the directors are.

Tax implications of director’s loans 

If a director withdraws more money from the company than their invested capital, aside from salary or dividends, it is referred to as a director’s loan. Taking out excess dividend payments can also be considered a director’s loan. If the loan is not repaid within nine months after the Corporation Tax accounting period ends, they’ll be required to pay 33.75% of the outstanding amount in Corporation Tax. This tax is known as section 455 and is a company liability which is only repayable to the company nine months after the year-end in which the loan is repaid or cleared via a dividend. As a result, timing of any repayment of a loan can be crucial from a cashflow perspective.  

FAQs

Can a shareholder waive their entitlement to dividends?

Yes – a shareholder can waive (or partially waive) their entitlement to a dividend, and such waiver can cover a specific dividend or a number of dividends within a certain period or all future dividends. However, drafting any waiver document is a ‘reserved activity’ that can only be carried out by a solicitor – specialist guidance and advice should be sought.

In order to provide flexibility in the payment of dividends, companies can issue shares of differing share classes to different shareholders (e.g. Ordinary-A and Ordinary-B shares). This allows different amounts to be paid to shareholders without the need for waivers.

Is it possible to pay dividends to only some shareholders?

Dividends should be paid in proportion to shareholdings within the same class of shares. So, if all shareholders hold the same class, dividends usually need to be paid equally per share.

However, if a company has different share classes (e.g. A and B shares), it can choose to pay dividends to one class and not the other, depending on the rights attached to each class.