What are dividends and why might you want to draw them?

A relatively early decision to make after having formed a limited company is how you plan to draw money from your business account and pay yourself personally. Along with salary and potentially a Director’s Loan, this is where dividends come into the equation.

In this guide, we’ll run through everything you need to know about dividends – from what they are, the reasons for drawing them and the tax implications.

What is a dividend?

A dividend is a sum paid to a shareholder from the profits made by a business. This means dividends can only be drawn if there is enough money left to pay all of a company’s liabilities, such as tax and overheads.

Dividends vs salary: what’s the difference? 

So are dividends the same as salary? No, while both count as income , they are quite different from each other, with contrasting tax implications.

A dividend is paid from available profits to shareholders of the business after all tax and business expenses have been taken into account. The individual receiving the dividend will be liable for any tax due on dividends drawn, not the company.

Salary, on the other hand, is paid to employees (and often directors  too) and treated as a business expense. In other words, any salary paid to employees, plus employment costs reduces the profit your business makes and therefore lowers your Corporation Tax bill.

Do dividends help contribute towards tax efficiency? If so, how?

Lots of limited company directors pay themselves a low salary, which is then topped up by dividends. But why? Well, the combination of a low salary and dividends means you may legitimately qualify for lower rates of tax than you would when paying yourself entirely in salary.

This is primarily because dividends aren’t subject to National Insurance Contributions (NICs). In contrast, salary paid over the tax-free threshold (£8,440 for 2021/22) attracts employer’s NICs.

It all depends on your circumstances, though. As a limited company director, you can choose from a range of options when it comes to paying yourself an income.

 Are dividends taxable?

So how much tax is paid on dividends? Firstly, the annual dividend allowance means you can receive up to £2,000 in dividends, tax-free every year. This is on top of your Personal Allowance, which is the amount you can earn before paying any tax (£12,570 for 2021/22). After that, your dividend tax rate depends on your Income Tax band. We’ve broken things down below.

Band Tax rate Amount received
Personal allowance 0% £12,570
Dividend allowance 0% £2,000
Basic rate 7.5% £14,500 – £50,270
Higher rate 32.5% £50,271 – £150,000
Additional rate 38.1% £150,000 +

 How often are dividends paid?

Whenever you want. Other than contributing to tax efficiency, another benefit of dividends is that you can draw them as and when you need – they offer flexibility, which is important for tax planning and managing your personal cash flow.

Just make sure that you only draw dividends from profit – eat into money owed to HMRC or debtors and you’ll find yourself in hot water.

How do you issue a dividend?

 Every dividend needs to be declared, after having held a meeting between the directors of the company. When the dividend amount has been agreed, a ‘dividend voucher’ must be written up, showing:

  • Date of dividend issued
  • Company name
  • Name and address of shareholders paid
  • Amount of the dividend
  • Number of percentage of shares owned by the recipient of the dividend
  • Signature of the company director

The shareholder then needs to be given a copy of the dividend voucher, which should also be kept for your company records. If you have an accountant, they can take care of this for you easily.

So there you have it. Everything you need to know (initially at least) about drawing dividends as a way of paying yourself through your limited company. And remember, for more information and to receive expert support in this area, don’t hesitate to engage the help of a trusted accountant.