Business owners in the UK set up a limited company owing to its multiple benefits, including separate legal standing and limited liability protection to its members. In this blog, we will delve into discussing how dividends work in a limited company and how they are taxed to help you comprehend this crucial aspect of running a limited company.
For instance, the company assets are independent of the personal assets of its members. Likewise, in the event of the company’s financial collapse, the members’ financial liability will remain limited to however much they have invested in the business.
Moving ahead, investors choose a limited company to generate profits, which are distributed among the shareholders as per their share numbers and value. Notably, the profits are allocated among the shareholders through the dividends after paying the corporation tax.
To know more about the benefits of a limited company and how it is created, read our following guides respectively:
How to set up a limited company?
Limited company advantages and disadvantages.
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What are dividends?
A limited company does not directly receive all the profits it yields through its trading or business activities. Instead, the profits are first subject to corporation tax.
Moreover, after the company has paid all of the business-related costs, liabilities and taxes for the given financial year, it can then distribute the retained profits among its shareholders in the form of share dividend payment.
Dividends are payments that the limited company shareholders receive from the post-corporation tax profits. It is the portion of the company’s retained profits it distributes among the shareholders.
Alternatively, dividends are payments made to shareholders after a limited company has fulfilled its tax liabilities, such as corporation tax and VAT.
To learn more about corporation tax and VAT, read our comprehensive guides:
How to file corporation tax for limited companies?
What are the VAT requirements for a limited company?
Notably, dividends are the most tax-efficient way for an individual to withdraw money from a limited company if they are a part of it as a shareholder. Similarly, limited company directors are also entitled to receive dividends if they are also shareholders.
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How dividends work in a limited company?
The following points will elaborate on how dividends work in a limited company, including the frequency of their distribution, the method, and how they are taxed for shareholders:
How often are dividends issued?
Generally, a dividend is considered a form of profit distribution in companies limited by shares. There is also no constraint on how frequently the dividends must be issued.
For greater clarity, the dividend distributions vary based on the company’s size and profits or at the discretion of the company’s directors.
For instance, most small limited companies issue dividends on a regular basis (such as monthly) if they have sufficient profits to distribute owing to their sound financial standing. It helps the shareholders obtain a regular and consistent flow of income as a token of acknowledgement for their investment in the company shares.
On the flip side, large companies issue dividends every quarter. It means that the last dividend is issued at the end of the financial year when they have prepared their annual accounts.
It is worth pointing out that profit allocation and dividend payments are considerably straightforward in small limited companies. On the contrary, the process of dividend payments becomes complicated in companies that issue shares in different types and large quantities owing to their large sizes and extensive trading.
How does a limited company issue a dividend?
Issuance of dividends is significant to comprehend how dividends work in a limited company. A meeting of the board of directors is called for the specific purpose of declaring a dividend. Besides, dividends are typically distributed on the basis of the percentage of company shares that each shareholder owns.
It is noteworthy that all the details of the discussions occurring in the meeting must be recorded, even if the company has only one director.
Further, whenever a limited company makes a dividend payment, the director(s) must issue a dividend voucher that displays the following details:
- Company name.
- Date when the dividend is issued.
- Shareholders’ names who were paid dividends.
- Dividend amount.
Lastly, it is highly recommended to give a copy of the voucher to all the members who were paid the dividend amount and keep a copy for your company’s records.
How dividends work for shareholders in a limited company primarily depends on the profit the company has generated. To clarify, the payment of the dividends will be proportional to the amount of profit available at the time of distribution and the shareholdings each member has.
For instance, an individual who is the sole shareholder of the company will represent 100% ownership of the company. As a result, they will be entitled to claim 100% of available profits in the form of dividend payments.
Similarly, for a company with two shareholders, each will own 50% shares. Subsequently, each shareholder can claim 50% of available profits in the form of dividend payments.
If you are planning on becoming a shareholder, gaining insight into the shares and shareholders of a limited company might be beneficial for you. Accordingly, our following posts can be of immense help in this regard:
What are limited company shares? Things you must know about?
What are different types of shares in a limited company?
A comprehensive guide to limited company shareholders.
How much tax do you pay on dividends?
Having a clear understanding of how dividends are taxed in the UK is the most essential aspect of knowing how dividends work in a limited company. This is because dividend payments come with tax liabilities.
Moreover, how much tax do you pay on dividends depends on your total taxable income and the income tax band they fall in. Also, this tax is above your dividend allowance, which is tax-free.
It is important to highlight that you are not liable to pay any tax on your income from dividends if they fall within your annual Personal Allowance. The annual personal allowance for shareholders is set at £12,570 for the 2024/25 tax year.
What is tax-free dividend allowance?
The dividend allowance is the amount of dividend that is tax-free, i.e. it is the amount you have no tax obligation on. More specifically, it is the first £500 dividend payment you can get before you will have to pay tax on dividends for tax year 2024/25.
What are dividend tax rates for 2024/25?
Take note that you can determine the tax on dividends by calculating your income tax band at the following rates:
| Tax Bands | Tax rates on dividends (%) | Annual Income | Income tax rates on annual income (%) |
| Tax-free personal allowance | 0 | £12,570 | 0 |
| Basic Rate | 8.75 | £13,570 to £50,270 | 20 (For £12,571 to £50,270) |
| Higher Rate | 33.75 | £50,271 to £125,140 | 40 (For £50,271 to £125,140) |
| Additional Rate | 39.35 | over £125,140 | 45 (For over £125,140) |
For further information about Tax rates on Dividends and Income Tax Rates you can visit government’s official websites.
Filing self-assessment tax return:
It is obligatory for shareholders to report their dividend income to HMRC by registering themselves for self-assessment. Dividend income is reported to HMRC following the end of every tax year.
Accordingly, you must complete and file your self-assessment tax return with HMRC and pay the correct amount of tax on your annual dividend income. Lastly, any other tax due can also be paid via self-assessment.
Conclusion:
A dividend is the percentage of the limited company’s retained profits it pays its shareholders. Therefore, understanding how dividends work in a limited company and what rates they are taxed at is crucial to ensure compliance with HMRC.
Furthermore, with the help of a skilled and certified accountant, you can always have your tax obligations fulfilled seamlessly by letting them manage all your tax affairs on your behalf. Hence, visit Accountingfirms to find an affordable and competent accountant.
Disclaimer: The information provided on AccountingFirms.co.uk is for informational purposes only and should not be considered as financial advice. Always consult with a professional accountant to ensure compliance with UK laws and regulations.