A dividend is a distribution of a company’s post-tax profits to its shareholders. Paying dividends is one of the main ways that owners of private limited companies extract value from their business. However, dividends must be declared and paid following a specific legal procedure set out in the Companies Act 2006.
Distributable Profits Requirement
A company can only pay dividends out of distributable profits. Distributable profits are a company’s accumulated realised profits (less any previously distributed or capitalised amounts) minus its accumulated realised losses.
| Term | Meaning |
|---|---|
| Realised profits | Profits that have been earned and recognised in the accounts |
| Realised losses | Losses that have been incurred and recognised |
| Distributable profits | Realised profits minus realised losses (the cumulative figure, not just the current year) |
| Retained earnings | The balance sheet reserve that typically represents distributable profits |
If the company does not have sufficient retained earnings, it cannot legally pay a dividend. Paying a dividend without sufficient profits is an unlawful distribution, and directors who authorise it may be personally liable to repay the amount.
Checking Distributable Profits
Before declaring a dividend, directors should review the company’s most recent accounts to confirm that distributable profits are sufficient. For an interim dividend, this means reviewing up-to-date management accounts. For a final dividend, the statutory annual accounts are used.
Types of Dividends
| Type | Declared By | When |
|---|---|---|
| Interim dividend | Board of directors | Any time during the financial year |
| Final dividend | Shareholders (on board recommendation) | At the annual general meeting or by written resolution |
Interim Dividends
An interim dividend is declared by the board of directors without needing shareholder approval (provided the articles of association permit it, which the model articles do). Most owner-managed companies pay interim dividends throughout the year.
Final Dividends
A final dividend is recommended by the directors and approved by the shareholders by ordinary resolution. The shareholders can reduce the recommended amount but cannot increase it.
Step-by-Step Dividend Procedure
Step 1: Check Distributable Profits
Review the accounts to confirm that the company has sufficient distributable profits to cover the proposed dividend. If the company has made losses in previous years, these reduce the cumulative distributable profits even if the current year is profitable.
Step 2: Hold a Board Meeting and Record Minutes
The directors must hold a board meeting (or pass a written board resolution) to confirm distributable profits are sufficient, declare the dividend (or recommend a final dividend to shareholders), set the amount per share, the payment date and the record date.
The board minutes must record the date, directors present, confirmation that distributable profits have been reviewed, the dividend amount, payment date and the resolution passed.
Step 4: Shareholder Approval (Final Dividends Only)
For a final dividend, the shareholders must pass an ordinary resolution (simple majority) approving the dividend. This can be done at a general meeting or by written resolution.
Step 5: Prepare Dividend Vouchers
A dividend voucher (also called a dividend counterfoil or tax voucher) must be provided to each shareholder for every dividend payment. The voucher must include:
| Required Information | Detail |
|---|---|
| Company name | Full registered name |
| Date of payment | The date the dividend is paid |
| Shareholder name | Name of the recipient |
| Number of shares held | The shares on which the dividend is paid |
| Dividend per share | Amount per share |
| Total dividend | Total amount payable to that shareholder |
| Tax credit | No longer applicable (abolished April 2016), but the voucher is still required |
Dividend vouchers are essential records. Shareholders need them for their Self Assessment tax returns, and the company needs them as evidence that the dividend tax obligations have been properly documented.
Step 6: Pay the Dividend
Transfer the dividend amount to each shareholder. Payment is usually made by bank transfer directly to the shareholder’s personal bank account. The dividend is paid gross (without deduction of tax at source).
Tax on Dividends
Dividends are subject to dividend tax in the hands of the shareholder. Every individual has a dividend allowance, a nil-rate band for the first slice of dividend income. Dividends above the allowance are taxed at the dividend ordinary rate, upper rate or additional rate, depending on which Income Tax band they fall into. HM Treasury sets the allowance and the rates at the Budget, so check the current figures on GOV.UK before planning a payment.
The company does not deduct tax when paying dividends. The shareholder reports dividend income on their Self Assessment tax return and pays any tax due.
Dividends and Directors
In many owner-managed companies, the directors are also the shareholders. A common tax-efficient strategy is to pay a low salary (at or below the National Insurance threshold) topped up with dividends, because dividends are not subject to National Insurance contributions.
However, dividends must still be paid out of distributable profits and must follow the correct procedure. HMRC may challenge arrangements where dividends are paid without proper documentation or where there are insufficient profits.
Illegal Dividends
A dividend paid when the company does not have sufficient distributable profits is an illegal dividend (unlawful distribution). The consequences include:
- Directors who knew or ought to have known there were insufficient profits may be liable to the company for the amount of the unlawful distribution
- Shareholders who knew or had reasonable grounds to believe the distribution was unlawful must repay the amount received
- The payment may need to be reclassified as a director’s loan, with tax consequences
Record Keeping
The company must retain the following dividend records:
- Board minutes recording the declaration
- Shareholder resolution (for final dividends)
- Dividend vouchers for each payment
- Bank statements showing the payments
- Management accounts or statutory accounts used to verify distributable profits
These records should be kept for at least 6 years for tax purposes.