If your limited company has any retained profits, after all expenses and taxes have been paid, these funds can be distributed to the company’s shareholders in the form of dividends.
Here we look at how dividends work, how to account for them, and how much tax you have to pay.
Why are dividends tax-efficient?
For contractors and other small company owners who fall outside the IR35 rules, working via a limited company is a tax-efficient way of working, although this benefit was reduced in April 2016 when the rates of dividend tax were increased significantly.
Most company directors are paid a small salary. The rest of their income can be drawn down as dividends, which are free from National Insurance Contributions.
Limited company directors also benefit from tax planning options unavailable to employees; shares can be gifted to a spouse (making the most of a non-working partner’s tax allowances), and dividend distributions can be deferred to future tax years to minimise exposure to higher and additional rates of income tax.
What size of dividend can my company distribute?
To calculate the available profits your company can distribute to its shareholders as dividends, you should deduct all company expenses (salary, taxes, expenses, accountancy fees, etc.) and other costs from your company turnover.
Then subject the remaining capital to the prevailing rate of Corporation Tax (19% in the 2020/21 tax year).
You are free to distribute any ‘retained profit’ in the form of dividends to shareholders, in proportion to the percentage of shares they own in the company.
Your online software should tell you exactly how much you can distribute at any one time.
This is a simplistic explanation; you should, of course, contact your accountant to ensure that you only distribute funds legitimately, otherwise they will be ‘ultra vires’ (unlawful), and subject to possible HMRC penalties.
How much tax do you pay on dividends? (from April 2016 onwards)
Dividend tax is applied at the following rates, according to the tax bands they sit within.
- Basic Rate (7.5%)
- Higher Rate (32.5%)
- Additional Rate (38.1%)
A tax-free ‘dividend allowance’ applies to the first £2,000 of dividends, although – importantly – the allowance sits within a taxpayer’s existing tax band for taxation purposes.
Dividends are taxed after all other sources of income have been accounted for, such as investment, savings, and property income. You should account for any dividend income you receive each year via Self Assessment.
You can find out how to work out your personal tax liability on dividends you receive by using our dividend tax calculator.
When paying dividends from your limited company, you must make sure that you prepare company board minutes for each dividend declaration. Your accountant will typically help you prepare them, or they will be automatically generated by your accounting software, e.g. FreeAgent.
You must also prepare a dividend voucher for each shareholder. Limited company dividends are treated the same way as all UK company dividends (for example, LSE quoted companies).
The voucher will state the total dividend paid. Prior to the changes to dividend taxation from April 2016 onwards, dividend vouchers would also have contained both the net and gross dividend amounts, plus the 10% tax credit.
How often should you declare dividends?
It is up to each company board to decide how often they pay dividends. Many small company directors choose to distribute dividends on a quarterly basis, but there are no official restrictions on how often you can declare them.
Once you have declared a dividend, you don’t have to extract the money right away – you have just declared your intention to distribute funds.
There will also be further personal tax to pay on the dividends you receive if you are a higher or additional rate taxpayer. You will pay any personal tax liabilities via the annual self-assessment process.