The complete guide to dividends

Dividends are a way of taking profit after tax from your limited company. They are considered to be the most tax efficient way of paying yourself compared to drawing a salary.

As with most tax legislation, dividends can be a bit tricky to navigate if you don’t know what you’re doing. It’s important to get things right, as you could face financial penalties or even prosecution if you don’t play by the rules.

To help, we’ve created this handy guide to give you some of the basics.

What types of dividends are there?

As a small business owner, you can pay yourself and any shareholders two types of dividends.

  1. Interim dividends
  2. These can be withdrawn at various points during the financial year, as long as there are enough reserves in the company. If you don’t have sufficient profit remaining after tax, any dividends issued will be treated as illegal – or ‘ultra vires’.

    In this situation, your payments will be voided by HMRC and could even be classed as employment income. This means you’ll have to pay more in tax.

  3. Final dividends

You declare a final dividend after your business has issued its full-year financial statement. Any net profit that’s remaining in the business at this point can be withdrawn if you wish.

How do I pay dividends?

Dividends are issued according to the proportion of shares a person owns in your company. If you’re the sole shareholder, then you’ll keep 100% of the amount withdrawn.

Before issuing dividends, you need to hold a board meeting with your shareholders to agree the amount that will be issued. Of course, that’s not necessary if you’re the only one.

The next step is to issue a dividend voucher to your shareholders – even if you own 100% of your company. Each voucher should contain the following information:

  • Date
  • Company name
  • Name and address of recipient
  • Number of shares held
  • Net dividend payment
  • Director’s signature

How are dividends calculated?

The first thing you need to do is deduct all your company’s expenses (salary etc) and other costs from your turnover. You then have to subtract small business tax, which leaves you with your final profit amount – known as retained profit. This can then be distributed as dividends.

How are dividends taxed?

The amount of tax you’ll pay on your dividends depends on how much you withdraw. The first £5,000 of this will be tax-free, known as your dividend allowance.

You’ll then be charged tax at the following rates:

  • 7.5% up to the basic rate band
  • 32.5% within the higher rate band
  • 38.1% within the additional rate band

The dividend allowance can also be used in conjunction with your £11,000 Personal Allowance if you pay yourself a salary. This means that if you receive a wage of £4,000, the first £12,000 of dividends will be tax-free.

Examples

To illustrate this better, here are a few example scenarios:

  • You withdraw £25,000 in dividends and draw a salary of £11,000

This example illustrates what would happen if you used your full personal allowance and didn’t draw sufficient dividends to take you above the basic rate threshold.

Step one:

Subtract the £5,000 dividend allowance.

£25,000 – £5,000 = £20,000

Step two:

Multiply the remaining amount by the basic rate of tax (7.5%) to work out how much dividend tax you’ll pay.

£20,000 x 7.5% = £1,500

  • You withdraw £50,000 in dividends and draw a salary of £11,000

This example illustrates what would happen if you used your full personal allowance and withdrew a dividend amount that takes you above the basic rate threshold.

As before, the first £5,000 is tax-free. However, because you’ve exceeded the basic rate threshold, a proportion of your dividends will be charged at the higher rate of 32.5%.

Step one:

Subtract the £5,000 dividend allowance.

£50,000 – £5,000 = £45,000

Step two:

Multiply the first £27,000 of dividends (the remainder of the £32,000 basic rate threshold) by the basic rate of tax (7.5%).

£27,000 x 7.5% = £2,025

Step three:

Multiply the remaining £18,000 of dividends by the higher rate of tax (32.5%).

£18,000 x 32.5% = £5,850

Step four:

Add the two amounts together to find out how much dividend tax you’ll pay.

£2,025 + £5,850 = £7,875

  • You pay yourself £30,000 in dividends but also take a salary of £7,000

This example illustrates what would happen if you didn’t use all of your personal allowance and didn’t withdraw sufficient dividends to take you above the basic rate threshold.

Because you’ve only used £7,000 of your Personal Allowance, the remaining £4,000 will be added to your dividend allowance. This means the first £9,000 of dividends will be tax-free.

Step one:

Subtract your £9,000 dividend allowance

£30,000 – £9,000 = £21,000

Step two:

Multiply the remaining amount by the basic rate of tax (7.5%) to work out how much dividend tax you’ll pay.

£21,000 x 7.5% = £1,575

Don’t forget, you’ll also be charged Income Tax and National Insurance on your salary if you go above the relevant thresholds.

Need more help?

We hope this guide has taught you everything you need to know about dividends. If you still want more information, look no further than our dedicated team of experts.

Our accountants and tax specialists are on hand to advise the most tax-efficient ways to pay yourself – based on your own personal circumstances. They will also calculate your tax liability on your behalf, so you don’t need to worry.

This means you can be sure you’re taking home the right amount, leaving you free to concentrate on running your business. For more information, or to sign up, please call 08000 149 597 or email info@clearskybusiness.co.uk.

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