Stuart Crook FCA, explains how dividends work and their treatment for the purposes of taxation.
Have you just opened a business and incorporated it?
Or, perhaps you've changed the legal structure of your business to a limited company?
Whatever your circumstances, you'll likely have heard of dividends in business circles but may not yet know much about them. So, if you're operating through a limited company, this post will help you by explaining the concept of dividends, when they can be distributed, and also answer the key question, what are the dividend tax rates? Read on to find out more.
A dividend is a payment to shareholders from the profits made by a limited company. This means a company can only make a dividend payment if it is profitable. Any pay out therefore can't be greater than the profits generated in the current and previous financial years.
Profit refers to the money your company has remaining after paying all its tax liabilities (such as VAT and Corporation Tax), and expenses (think wages and rent for premises). It's illegal to pay out a dividend if your company doesn't have sufficient profit, after tax, to cover the amount of dividends. Of note, unlike salaries, dividend payments can't be classified as a business expense.
Profit can be accumulated over many years in your limited company and this is known as "retained profit". Consequently directors don't necessarily have to distribute profits for the end of the company's accounting year as dividends. Instead you can keep the profits in your business and you can then make them available for distribution at some point in the future.
Typically, shareholders will draw the bulk of their earnings in the form of dividends as, depending on their personal financial circumstances, this could be the most tax efficient way of extracting money out of your business.
How to issue a dividend
To issue a dividend you'll need to hold a meeting of your directors and firstly, declare a dividend. This meeting has to be minuted and a record retained of it for legal reasons. These are included in the year end approval documents when your accounts are signed.
You could print a copy of the balance sheet, and profit & loss account for the period in which the dividend is being distributed. This helps to ensure the payment doesn't exceed the profits that are available in the business bank account.
Each dividend payment you make has to be issued as a dividend voucher. All recipients of dividends need to be given a copy of the voucher and a copy must be kept for your accounting records. The voucher must contain:
Your company name
The company registration number
The names of all your shareholders being paid dividends
The date of when your dividend is paid out
The cash amount of your dividend
Signature of the authorising officer
Working out dividend payments
Dividends are recorded in your accounts when they are set to be paid out. The payment amounts are usually calculated by the percentage of company shares that are owned by each individual shareholder.
If you have 4 shareholders with an equal split of all shares, then each of them will receive 25% of all dividends distributed. So, if you have £4,000 of retained profit then each shareholder would receive a dividend payment of £1,000. However, there are exceptions to this rule, and we cover more on that point later in this post.
Also, a word of warning, any dividends not properly recorded could be seen as directors' loan account, and that means the result could be additional taxes for the company and individual(s) in question.
How much can you take in dividends? What to be aware of
Often the assumption is dividends can be paid out of any cash in the business bank account. However, that's not necessarily the case. A limited company can distribute the whole of its accumulated realised profits, less its accumulated realised losses.
The reality however, is that unrealised losses also need to be factored in. This means you can't have dividend payments based on accounts that show profits, if subsequent losses then eliminate those earnings. Directors are personally liable to the company should an unlawful dividend payment be deemed to have taken place.
The Companies Act stipulates that shareholders are liable to repay a dividend distribution, if at the time of the payment, they knew, or had potential knowledge, that it could be illegal.
You also need to review the company's Memorandum of Articles which may include statements that restrict dividends in certain circumstances. Also, different types and classes of shares may exist, and these can impact on entitlement to dividends and voting rights. Details of the company’s shares and the rights attached to them are covered in the statement of capital.
The timing of when to pay dividends, how often can they be issued?
Typically, dividends are paid when your year end figures have been agreed and there is sufficient cash available in the business. These are known as final dividends. The reality however, is you can pay yourself dividends whenever you want, provided the money is available in the business.
If it's a payment that's not at your year end, then these are known as interim dividends. This means there is no limit to the number of dividends your company can issue throughout the year subject to financial performance, and retained profit.
You only need to issue one dividend for each shareholder, every time you declare dividends. This also means the more dividends you issue, the more admin and paperwork you'll have to complete.
How and when to make a dividend payment can have also personal tax implications dependent on when certain tax changes are introduced, and your level of personal income. It is therefore wise to seek professional advice regarding profit extraction so that you have full awareness of the potential, estimated tax liabilities.
The dividend rates of tax
Currently, you don't need to pay tax on the first £1,000 of dividend income that you receive, this is know as the tax-free dividend allowance. However, from April 2024, it will be reduced to £500.
Beyond the tax-free allowance, the amount of tax you owe is determined by the tax bracket you fall into, which is influenced by your overall income. This is commonly known as your marginal tax rate.
This means you get the dividend allowance and your other income qualifies you for the personal allowance for income tax. For the 2023/24 tax year this is £12,570 meaning you can earn potentially £13,570 income before having to pay any tax. The tax rates for dividends work in conjunction with income tax bands as follows.
Income tax bands
Dividend tax rates 2022/23
(income of £12,570 - £50,270)
(£50,271 - 150,000)
How to pay the tax on dividends?
If you earn income above the allowance but under £10,000 then you'll need to inform HMRC. The tax can then be paid either by:
Filling out a self-assessment tax return or;
Getting HMRC to adjust your tax code thereby ensuring it is taken from your salary or pension
If you earn income above £10,000 in dividends then you'll need to fill in and complete a tax return. You have to declare this income in the dividends section of the form.
Payment can then be made to HMRC via the payment on account system. As a tip, it would be wise to set money aside with each dividend issue. That way you'll then have funds to hand for when you complete your tax return and HMRC notify you of the tax amount you need to pay.
This post was created on 29/10/2021 and updated on 03/10/2023.
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