Dividends are a type of payment limited companies can make to shareholders from their profits. They can be a useful way to reward investment or performance, but the tax rules for dividends are different to other types of income. In this article we’ll explain how dividends work for limited company shareholders.

Can any business pay dividends?

Only limited companies pay dividends, because this is the only type of business structure which issues shares. Someone running a different type of business (such as a sole trader) can simply keep the profits they make, but limited companies are a separate legal entity to the people that own them so they need to use the more formal process of declaring dividends.

Some people find this makes the idea of operating as a limited company more appealing because:

• Dividends are taxed at a lower rate than other types of income
• The profits can stay in the company and then paid out over a longer period of time (which allows you to be more efficient with the way you use tax allowances and thresholds, rather than paying out a lump sum and getting hit with a larger tax bill)

How are dividends worked out?

Companies make dividend payments to their registered shareholders according to the proportion and type of shares they hold. In some businesses the shareholders are also directors in the company, but not always.

This means some companies create different types of shares so they can be more flexible with what shareholders are entitled to, based on their role in the business.

What is the difference between shareholders and directors?

Shareholders own the company by having shares in it. They are often known as ‘members’. Directors manage the business and the way it operates, and tend to be much more hands-on. In some smaller businesses there might be just one person who is both the only shareholder and sole director.

How much can a company pay in dividends?

In theory there aren’t any limits on declaring dividends if the company has profits available to pay them after paying its tax bill and any other liabilities. In practice, it’s normally a very good idea to leave something in the business to fund future growth and help manage cash flow!

Because profits can fluctuate depending on what sort of year the business has had, the amount available for dividends can also vary (which is why dividends are often paid at the end of the company’s financial year). The amount that a shareholder receives as a dividend also depends on how many shares they own, and what sort of shares they are.
 

Can directors still take a salary if they receive dividends?

Yes absolutely! Lots of company directors who are also shareholders take both a salary and dividends because it can be a more tax efficient way to pay themselves from the business. It can be a bit complicated, so we have a separate article which explains director’s salaries in more detail.

What are the tax implications of taking a dividend?

Dividends aren’t taxed at source in the same way salaries are, so you’ll need to submit a Self Assessment tax return to make sure you pay the right amount of tax on any dividends you receive.

 
Dividends are taxed at a different rate to other types of income, although the rate you’ll be charged is based on the total amount of income you receive in a year. Use our online dividend tax calculator to see how much you can expect to pay in tax on this type of income.

You’ll also be entitled to a £500 tax-free dividend allowance, which you get on top of the annual £12,570 Personal Allowance.

 
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