What Are Dividends?

Dividends are distributions of a company’s profits to its shareholders. They represent a return on the shareholders’ investment and are one of the two main ways shareholders benefit from owning shares – the other being capital growth.

Dividends can only be paid out of distributable profits, which are broadly the company’s accumulated realised profits less accumulated realised losses. This rule, set out in the Companies Act 2006 (Part 23), prevents companies from returning capital to shareholders disguised as dividends.

Types of Dividends

Type	Description
Interim dividend	Paid during the financial year, usually declared by the directors without shareholder approval
Final dividend	Proposed by the directors after the year end and approved by the shareholders at the annual general meeting
Special dividend	A one-off distribution, often following the sale of an asset or an exceptionally profitable period

Most private companies in the UK pay dividends on an interim basis throughout the year, with a final dividend declared after the year-end accounts have been prepared.

Legal Requirements

Distributable Profits

A company must have sufficient distributable profits to cover any proposed dividend. Distributable profits are calculated as:

Accumulated realised profits - Accumulated realised losses

This includes retained earnings brought forward from prior years. A company that made a loss in the current year may still pay a dividend if it has sufficient retained earnings from previous years.

Item	£
Retained earnings brought forward	120,000
Profit for the current year	45,000
Accumulated distributable profits	165,000
Dividends already paid this year (interim)	(30,000)
Available for further distribution	135,000

Unlawful Dividends

If a dividend is paid when the company has insufficient distributable profits, it is an unlawful dividend. The consequences include:

Directors who authorised the payment may be liable to repay the amount to the company
Shareholders who knew or ought to have known the dividend was unlawful may be required to return it
HMRC may treat the payment as something other than a dividend for tax purposes

Board Resolution

Dividends must be formally declared by the board of directors. A board minute should record:

The date of the resolution
The total amount of the dividend
The per-share amount
The date of payment
The shareholders entitled to receive the payment

Accounting for Dividends

Declaring and Paying an Interim Dividend

The board declares an interim dividend of £20,000:

On the payment date:

Account	Debit (£)	Credit (£)
Dividends paid	20,000
Bank		20,000

The dividend paid is shown as a deduction from retained earnings in the statement of changes in equity, not as an expense in the income statement.

Final Dividend

Under FRS 102, a final dividend proposed after the year end but before the accounts are approved is not recognised as a liability at the balance sheet date. It is disclosed in the notes to the accounts as a post-balance-sheet event. The dividend is recognised when it is formally approved by the shareholders.

Timing	Treatment
Before year end (interim paid)	Recognised and deducted from retained earnings
After year end but before accounts approved (final proposed)	Disclosed in notes only
After shareholder approval	Recognised as a liability and paid

Dividend in the Statement of Changes in Equity

	£
Retained earnings at start of year	120,000
Profit for the year	45,000
Interim dividends paid	(20,000)
Final dividend of prior year paid	(15,000)
Retained earnings at end of year	130,000

Dividends and Tax

Corporation Tax

Dividends are paid out of after-tax profits. They are not a deductible expense for corporation tax purposes. The company pays corporation tax on its profits, and dividends are then distributed from the remaining post-tax amount.

Dividend Tax for Shareholders

Shareholders receiving dividends pay dividend tax at rates that depend on their income tax band:

Tax Band	Dividend Tax Rate (2024/25)
Basic rate (up to £37,700 of taxable income above the personal allowance)	8.75%
Higher rate (£37,701 to £125,140)	33.75%
Additional rate (over £125,140)	39.35%

Every individual has a dividend allowance of £500 (2024/25), below which no dividend tax is payable.

Tax Efficiency

For owner-managed companies, paying a combination of a small salary and dividends is often more tax-efficient than taking a large salary, because:

Dividends do not attract National Insurance (neither employer’s nor employee’s)
Dividend tax rates are lower than the equivalent income tax rates
A salary up to the NIC primary threshold (or the personal allowance) can be paid tax-free

Payment Method	Income Tax	Employee NIC	Employer NIC
Salary of £50,000	Yes (at marginal rate)	Yes (8% above threshold)	Yes (13.8% above threshold)
Salary of £12,570 + Dividend of £37,430	Salary: nil (within personal allowance); Dividend: 8.75% on amount above £500 allowance	Salary: nil (below threshold); Dividend: nil	Salary: nil (below threshold); Dividend: nil

The exact savings depend on individual circumstances, and HMRC may challenge arrangements that lack commercial substance.

Dividends Versus Drawings

In unincorporated businesses (sole traders and partnerships ), owners take drawings rather than dividends. The key differences:

Feature	Dividends	Drawings
Business type	Limited company	Sole trader / partnership
Legal restriction	Must have distributable profits	No legal restriction
Tax treatment	Taxed at dividend tax rates	Not separately taxed (owner taxed on profit)
NIC	No NIC payable	Class 2 and 4 NIC on business profit
Formal approval	Board resolution required	No formal process

Dividend Policy

Directors must balance competing demands when setting dividend policy:

Consideration	Implication
Shareholder expectations	Shareholders expect a reasonable return on their investment
Cash availability	Distributable profits may exist on paper, but the company needs cash to pay dividends
Future investment	Retaining profits funds growth without the need for external borrowing
Tax planning	Timing and quantum of dividends affect shareholders’ tax positions
Loan covenants	Bank facilities may restrict dividend payments or require minimum retained earnings
Working capital needs	Paying excessive dividends can leave the company unable to meet its obligations

Dividends in the Cash Flow Statement

Dividends paid are reported under financing activities in the cash flow statement:

Financing Activities	£
Proceeds from new bank loan	50,000
Repayment of bank loan	(20,000)
Dividends paid	(35,000)
Net cash from financing activities	(5,000)

Dividend Vouchers

For each dividend payment, the company should issue a dividend voucher (also called a tax voucher) to each shareholder. The voucher records:

The company name and registered number
The shareholder’s name
The date of payment
The number of shares held
The dividend per share
The total dividend amount

Shareholders need this information to complete their self-assessment tax returns.

Dividends and Company Law

The Companies Act 2006 imposes several requirements:

Dividends can only be paid from distributable profits (accumulated realised profits less accumulated realised losses)
Public companies have the additional requirement that the net assets must not fall below the aggregate of called-up share capital and undistributable reserves
Directors must have reasonable grounds for believing the company will be able to pay its debts as they fall due after the dividend is paid
If interim accounts are needed to justify a dividend, they must be filed with Companies House (for public companies)

Paying a dividend when a company is insolvent – or when doing so would render it insolvent – exposes directors to personal liability for misfeasance or wrongful trading.