When you set up a company limited by shares, you will most likely want to issue dividends to yourself, in addition to your regular director’s salary. But what are dividends? How often do you pay them? And do you have to pay tax on dividends?
In this blog, we answer all of these questions, helping you to get to grips with this important aspect of running a limited company.
What are dividends?
A dividend is a form of profit distribution used by companies limited by shares. When a company generates profit and accrues retained earnings, the directors will usually reward eligible shareholders with financial payouts in the form of cash dividends.
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’s shares.
The amount that is paid out in dividends will depend on how much profit is available to distribute at the time and what percentage of shareholdings each member has. For example:
- If you are the only shareholder and you own one share, that share entitles you to 100% of available profits in the form of dividend payments
- If your company has 4 shareholders and each person owns one share, those shares entitle each shareholder to 25% of available profits in the form of dividend payments
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, and public companies that trade in the stock market.
Do all companies pay dividends?
Not all companies pay dividends.
Only companies with share capital can issue dividends, including public limited companies (PLCs), private companies limited by shares, and private unlimited companies.
It is not possible to issue dividends in limited by guarantee companies, private unlimited companies formed without share capital, or any type of partnership.
How often are dividends paid?
There is 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, issuing a final dividend at the end of the financial year when the year-end accounts have been prepared.
However, many smaller companies choose to issue dividends on a monthly basis to provide shareholders with regular income. Others may only pay dividends at irregular intervals when the company is in a good financial position and has profits available to distribute.
If you run a company on your own, or with one or two other people, paying monthly dividends to supplement low directors’ salaries may be the most practical and tax-efficient option. This is especially true if your company is your only source of income.
Are dividends paid in cash?
Generally, companies pay cash dividends to their shareholders. When cash dividends are distributed, the money can be paid in physical cash, by cheque, or by electronic bank transfer into the shareholder’s account
Larger corporations sometimes issue dividends in the form of stocks and shares or other types of assets, such as investment securities or property.
Do shareholders pay tax on dividends?
The ability to issue dividends to shareholders is one of the reasons why companies limited by shares are more tax efficient than sole traders, business partnerships, and LLPs.
Whilst shareholders do have to pay tax on dividend income above a certain amount, it’s charged at lower rates. This is because dividends are distributed from retained profits after tax, so companies have already been charged 19% Corporation Tax on these earnings.
No tax is payable on income from dividends that falls within the individual’s annual Personal Allowance (£12,570 for 2022-23 tax year). Additionally, all shareholders are entitled to a £2,000 dividend allowance each year.
Beyond these allowances, tax on dividends is determined by the shareholder’s Income Tax band and charged at the following rates:
- 8.75% (basic rate tax band) – annual income up to £50,270
- 33.75% (higher rate tax band)- annual income between £50,271 and £150,000
- 39.35% (additional rate tax band) – annual income above £150,000
Dividend income must be reported to HMRC through Self Assessment after the end of every tax year. Any tax due should also be paid through Self Assessment.
Shareholders are responsible for registering themselves for Self Assessment, completing and filing their own tax returns, and paying the correct amount of tax on their annual dividend income.