The profits generated by UK companies of all sizes can be distributed to shareholders as dividends. Limited company professionals, such as contractors and consultants, typically draw down the bulk of their earnings in the form of dividends.
This article explains what dividends are, how they are taxed, and how to properly account for them.
What is a dividend?
Dividends are payments made to company shareholders from the profits of a company after Corporation Tax.
Profit is the money the company has remaining after paying all business expenses and liabilities, plus any outstanding taxes (such as Corporation Tax and VAT).
By operating your business as a limited company the most tax-efficient way of extracting money from your company is usually via dividends.
It’s important to remember that dividends cannot be counted as a business expense when calculating your Corporation Tax and that it is illegal to pay a dividend if your company does not have sufficient profit after tax available to cover the dividend amount.
Any ‘retained profit’ in a limited company could have been accumulated over a number of months or years. If the director(s) choose not to distribute any excess profits as dividends at the end of the company’s financial year, then they remain available to distribute at a later date.
Usually, the most tax-efficient way to pay yourself as a limited company director is by taking a combination of salary and dividends from your limited company. The salary will be paid to you as a director, in the same way as a regular employee.
How does your company issue a dividend?
If you want to issue a dividend, then you need to hold a meeting of directors to “declare” the dividend. The meeting needs to be minuted and a record kept of it. This is the case even if you are the sole director of your limited company, though it may then just be a case of issuing the correct paperwork. If you use a good online accounting software system like Crunch, then it should usually take care of all the admin for you.
For each dividend payment your company makes, you need to issue a dividend voucher that shows the following:
- date the dividend is paid
- company name
- names of the shareholders being paid a dividend
- amount of the dividend
You should give a copy of the voucher to all recipients of the dividend amount and keep a copy for your company’s records.
Dividends should usually be distributed according to the percentage of company shares owned by each shareholder. So, If you own half the company’s shares, you should receive 50% of each dividend distribution.
Dividend tax explained
Your company does not need to pay tax on any dividend payments it issues, but the shareholders may have to pay tax on the dividends they receive based on their personal circumstances, through their annual Self Assessment. The following applies for the 2020/21 tax year.
Running your business as a limited company can be a tax-efficient way to operate, as neither the company nor you as an employee will need to pay National Insurance Contributions (NICs) on company dividends.
If you take a higher salary than the National Insurance (NI) Primary threshold, both employer’s and employee’s NICs would be payable. Many limited company owners combine dividend payments with a low salary to operate their business and their personal finances tax-efficiently.
Dividend allowance explained
You can earn up to £2,000 in dividends in the 2020/21 and 2019/20 tax years before you pay any income tax on your dividends, this figure is over and above your personal allowance of £12,500. For the 2018/19 tax year Dividend Allowance was also £2,000 but the Personal Tax Allowance was only £11,850.
The dividend allowance does not reduce the total income figure upon which you are taxed.
Dividends are taxed after your other income sources have already been taxed, e.g. your salary and other relevant income (from savings or investments). So, your dividends will fall into one or more of the tax bands listed above, after your personal allowance and other income sources have been added together.
Dividend tax rates 2020/21
The amount of personal tax you pay on dividends is the same as it has been for the past two tax years.
- Basic-rate taxpayers pay 7.5%
- Higher-rate taxpayers pay 32.5%
- Additional-rate taxpayers pay 38.1%.
Dividend tax thresholds 2020/21
The following tax rates and tax thresholds apply after the personal allowance of £12,500 is used.
|Tax Band||2020/21 Income||2019/20 Income||Tax Rate|
|Basic||£0 – £37,500||£0 – £37,500||7.5%|
|Higher||£37,501 – £150,000||£37,501 – £150,000||32.5%|
|Additional||£150,000 +||£150,000 +||38.1%|
To comply with the law, all companies must hold a board meeting to agree on a dividend declaration and record the meeting minutes in the company’s records. Of course, in practice, with many companies being run by sole directors, this is more of a paperwork exercise than anything.
Alongside the limited company paperwork, the directors must provide each shareholder with a dividend voucher. An electronic voucher (i.e. one attached via email, or automatically generated by an accounting software package) is perfectly acceptable these days if previously agreed by shareholders. Otherwise, the company should post a paper voucher to each shareholder.
The voucher should include:
- The date
- The company name
- The name and address of the recipient
- The total number of shares owned by the shareholder
- The total dividend payable to the shareholder (for dividends 6th April 2016 onwards)
- Director’s signature
It is essential that you maintain the correct paperwork – including paper records of board meeting minutes, as you may need to produce them in the unlikely event that you are selected for an HMRC investigation.
When can you issue a dividend?
There are no rules which determine how often you distribute dividends, however many accountants suggest processing dividend payments on a quarterly basis, for easier record keeping.
The most important thing you must remember is that all dividend distributions must be legal (i.e. there is sufficient retained profit in the company to cover them). Otherwise, they will be classed as illegal, or ‘ultra vires’, and could result in HMRC penalties and further action in some cases.
Unlike traditional employees, limited company owners are in the fortunate position that they can determine the timing of dividend payments, as well as the amounts to be distributed.
This can help in tax planning. For example, if you are working hard during the current tax year, with a view to taking a ‘career break’ next year, you would be wise to delay distributing some of your profits until the year when you will be earning less – and pay less higher rate tax by splitting the distribution over two separate tax years.
You may also benefit by splitting ownership of your company with a spouse, particularly if they don’t have any other source of income (or modest earnings). As a couple, you can take advantage of the non-working partner’s tax allowances, and pay less higher rate tax.
What is a dividend waiver?
It is possible for one or more shareholders to waive their rights to receive a dividend, so a dividend is distributed to some, and not all shareholders. Care should be used when considering the use of a dividend waiver, as if this is not done for genuine commercial reasons (such as ensuring that the company retains sufficient capital after the distribution), you may attract the attention of HMRC. Read our guide to dividend waivers, and how they work.
IR35 and dividends
If you enter into contracts to provide professional services to clients via your limited company (typically as an IT contractor), you may be aware of a piece of tax legislation called IR35.
If your contract work is caught by IR35, you will have to draw down the bulk of your company’s income in the form of a ‘deemed salary’, after allowing for a fixed 5% ‘administration allowance’ for the costs of running the company. Please note that if your contract is with a public sector organisation, you can no longer claim this allowance.
You will have to pay full PAYE income tax and NICs on this deemed salary – at the same rates paid by permanent employees.
So, if you do work as a limited company contractor, you should make IR35 compliance a key priority, as the financial consequences should you be caught are significant.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal or financial advice, nor is it a complete or authoritative statement of the law and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert legal or other advice should be sought.