When you set up a limited company, you’ll most likely want to issue dividends to yourself, in addition to your regular director’s salary. But what are dividends? How do they work? What’s the proper process for paying them? And do you have to pay tax on dividend income?
In this blog, we’ll answer all of these questions to help you get to grips with this important aspect of running a limited company.
Key takeaways
- Use dividends to compliantly take income from company profits, either on their own or alongside a director’s salary.
- Never pay more than you have in available profits or take a greater percentage than your shares entitle you to.
- As a director, you’re responsible for following the proper process to approve and record dividends as well as avoiding unlawful payments.
- Report dividend income to HMRC (usually through Self Assessment) and pay any tax you owe after applying your Personal Allowance and dividend allowance.
What are dividends?
A dividend is a form of profit distribution used by companies limited by shares. For example, directors will usually reward eligible shareholders with cash dividends when the company generates profit and accrues retained earnings.
In most small companies, dividends are issued on a regular basis. This provides shareholders with a steady stream of income in exchange for their investment in the company shares.
If you’re the sole shareholder of a small business, dividends can be a simple way to pay yourself from your limited company. This is often done in combination with a director’s salary.
Do all companies pay dividends?
Not all companies pay dividends, but those that commonly do include:
- Public limited companies (PLCs)
- Private companies limited by shares
- Private unlimited companies
Companies limited by guarantee can also distribute profits to members if their articles of association allow it. In practice, however, most limited by guarantee companies are set up as non-profits or registered charities and don’t pay dividends.
Unlimited companies without share capital may also be able to distribute profits if their articles of association allow it. This tends to be a less common arrangement, though.
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How do dividends work?
A company can only issue dividends when there are enough profits to do so. In other words, you can’t pay more dividends than the profits you’ve retained from the current or any previous financial years.
The amount that you’re allowed to receive in dividends also depends on how many shares you own. Generally speaking:
- If you’re the only shareholder and you own one share, you’re entitled to 100% of available profits in dividend payments.
- If your company has four shareholders, each with one share, they’re each entitled to 25% of available profits in dividends.
These are very basic examples, but profit distribution in small companies is often quite straightforward.
Dividends are usually more complex in bigger companies that issue large quantities and different types of shares. They also tend to be more complex in public companies that trade on the stock market.
How often are dividends paid?
There’s no strict timetable for issuing dividends. The frequency of distributions varies from company to company and is at the discretion of the directors.
Large companies often pay dividends every quarter. They’ll also issue a final dividend at the end of the financial year when the year-end accounts have been prepared.
Many smaller companies choose to issue dividends every month to provide shareholders with regular income. Others may only pay dividends when the company is in a good financial position and has profits available to distribute.
Interim vs final dividends: what’s the difference?
As the names suggest, the key difference between interim dividends and final dividends is timing. But first, let’s take a look at what these two types of dividends have in common.
Both interim and final dividends must be:
- Paid from available distributable profits
- Approved by following the correct process
- Recorded properly with a dividend voucher
- Distributed according to shareholder entitlement
And here’s how interim and final dividends differ:
| Key feature | Interim dividends | Final dividends |
|---|---|---|
| When are they usually paid? | During the financial year. | After the end of the financial year. |
| Who needs to approve them? | Company director(s) | Company shareholder(s) |
| Can payment be cancelled? | Yes. Directors can choose to cancel an approved payment. | No. Once approved, paying the dividend is a legal obligation. |
| When do they count as paid for tax purposes? | On the date the shareholder(s) receive the payment. | On the date of approval, unless the shareholder resolution specifies a future date. |
How do you pay yourself dividends? (step-by-step)
Every company, no matter how small, must follow the correct process when paying out dividends in order to stay compliant. This is true even if you’re the only director and shareholder of a business.
Here’s a common step-by-step process (under the model articles) for paying interim dividends:
| Action | Key considerations | |
|---|---|---|
| Step 1 | Check available profits and shareholder entitlement. | Dividend payments must not exceed available profits, or the percentage of profits each individual shareholder is entitled to. |
| Step 2 | Hold a directors’ meeting to declare the dividend(s). | Do this even if you’re the company’s sole director, take minutes of the meeting, and keep them for your records. |
| Step 3 | Write a dividend voucher for each dividend payment. | Include the date, company name, shareholder name, and dividend amount. Give a copy to the shareholder and keep a copy. |
| Step 4 | Pay the dividend(s) to the shareholder(s). | You can make dividend payments in cash, by cheque, or as an electronic transfer into the shareholder’s personal bank account. |
Keep in mind that this is just an example of what the process generally looks like for interim dividends. There may be times when you need to take different or additional steps such as seeking shareholder approval. This would be the case, for example, if you were paying final dividends.
Example: How are dividends calculated?
The most important thing to remember when calculating dividends is that cash available and profits available are not the same thing. Checking the balance in your business bank account isn’t enough. You’ll need to consult your company’s bookkeeping records, the latest set of accounts, and up-to-date management accounts.
With those financial records in hand, here’s a very basic formula you can use to calculate available dividends:
Profits brought forward + current year profits after Corporation Tax – dividends already paid = available dividends
Let’s say, for example, your company has £10,000 of retained profits from previous financial years. And, after Corporation Tax, your current year’s profits are £40,000. This gives you total accumulated profits of £50,000.
Let’s also assume you’ve already paid out £15,000 in dividends during that accounting period. So, the actual total you have available for dividend payments is £35,000.
Using the available dividends formula: £10,000 + £40,000 – £15,000 = £35,000
Remember, you’re only entitled to 100% of the available dividends if you own 100% of the shares in the company. If, for example, you own a 50% stake alongside a co-founder, then you’re only entitled to 50% of the total. In this case, £17,500.
What happens if you pay an illegal or unlawful dividend?
A dividend is considered unlawful if your company didn’t have enough available profits to cover the payment when it was made.
This is an important distinction. It’s not enough for total profits earned over the financial year to eventually cover the total dividends paid. Instead, you must show that at the time of declaring a specific dividend, the company had available profits to support it. Profits earned later in the year won’t fix an earlier dividend that was unlawful.
Here are the main consequences of paying an unlawful dividend:
- You may have to repay the dividend if you knew (or should’ve known) there weren’t enough available profits.
- You could be held personally liable as a director for approving the payment and may have to reimburse the company.
- In an owner-managed company, the payment might be treated as a director’s loan and needs to be repaid.
- Reclassification to a director’s loan could mean paying extra Corporation Tax or Benefit-in-Kind tax.
- You may need to correct your company accounts and update your director’s loan account to reflect the unlawful dividend.
- If your company becomes insolvent, you could face repayment claims, personal liability, or director disqualification.
If you think you’ve unintentionally paid an unlawful dividend, stop any further dividend payments and get professional advice straight away. From your accountant, for example, or a compliance service provider. They can advise you on the best course of action, which might include repaying the company and updating your records.
Are dividends paid in cash?
Companies typically pay cash dividends to their shareholders. These can be distributed in physical cash, by cheque, or by electronic bank transfer into the shareholder’s account.
Companies may also issue dividends as stocks and shares or other types of assets, such as investment securities or property.
Do shareholders pay tax on dividends in a UK limited company?
Shareholders do have to pay tax on dividend income, but only above a certain amount and at comparatively lower rates. This is one of the ways companies limited by shares are more tax-efficient than sole traders, partnerships, or LLPs.
As a shareholder, it’s your responsibility to comply with HMRC’s rules around reporting dividend income:
- If you receive up to £500 in dividends during the tax year, you don’t need to tell HMRC.
- If you receive between £500 and £10,000, you must tell HMRC. If you already send a Self Assessment tax return, you can report the dividend income there. If not, you can ask HMRC to update your tax code or contact the income tax helpline.
- If you receive over £10,000, you must report it to HMRC by filing a Self Assessment tax return. If you haven’t done so already, you must register for Self Assessment by 5 October follow the end of the tax year.
You’re also responsible for paying any tax you owe on dividend income.
Dividend tax allowances
All shareholders are entitled to a £500 dividend allowance each year, which means you can receive £500 in dividends tax-free.
Each shareholder is also entitled to an annual Personal Allowance. This is the amount of income you can earn in a year without having to pay tax on it. For most shareholders, this will be the standard 2026/27 Personal Allowance of £12,570.
Dividend tax rates
Shareholders must pay tax on any dividends they receive outside of their Personal Allowance and annual dividend allowance. The amount of dividend tax you’ll pay is determined by your tax band and charged at the following rates:
| Tax band | Annual income | 2026/27 dividend tax rate |
|---|---|---|
| Basic rate | £12,571 to £50,270 | 10.75% |
| Higher rate | £50,271 to £125,140 | 35.75% |
| Additional rate | Above £125,140 | 39.35% |
Dividend tax is charged at lower rates than other kinds of non-savings income, including a salary or profits from self-employment. This is because dividends are distributed from retained profits after tax. In other words, companies have already been charged Corporation Tax on these earnings.
Keep your company compliant
There’s a lot of freedom that comes with setting up your own company, but there’s also a lot of responsibility. Handling dividends properly is just one of the many things you’ll need to do to keep your company compliant.
If you need a hand, our Hassle-Free Compliance service takes care of all the essential compliance tasks for you. You’ll also get ongoing support from our team of experts whenever you need practical advice – and more.
We’re here to help you at every stage of your journey from getting started through to long-term success.
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