The retained profits generated by UK companies of any size can be distributed to shareholders. For professional workers like contractors, consultants and freelance workers, dividends make up the bulk of income drawn down from small limited companies.
If a limited company makes a profit, it is free to distribute these profited funds to its shareholders. This is money is what is left after paying all business expenses and liabilities, plus any outstanding taxes including Corporation Tax and VAT.
This ‘retained profit’ may have been accumulated over a period of time, and any excess profits not distributed as dividends simply remain in the company’s bank account.
Working via a limited company is a tax efficient way to operate, as National Insurance Contributions (NICs) are not payable on company dividends. NIC’s are payable on salaried income.
Dividends are distributed according to the percentage of company shares owned by each shareholder. For example if you own 45% of the company’s shares, you will receive 45% of each dividend distribution.
In order to comply with the law, all companies must hold a board meeting to agree the dividend declaration and this has to be recorded in the meeting minutes and kept in the company’s records. This is in practice more of a paperwork exercise as sole directors run many companies.
Accompanying this paperwork, the directors must provide each shareholder with a dividend voucher. An electronic voucher, for example one attached via email or automatically generated by an accounting software package, is an acceptable practice, if previously agreed by shareholders. If the electronic voucher were not an option the company would need to post a paper voucher to each shareholder.
The correct paperwork needs to be maintained as well as including paper records of board meeting minutes, as you may need to produce them in the event that you are selected for an HMRC investigation. This is not likely but shows the importance of keeping your records up to date.
Please note that the dividend taxation system was changed on 6th April 2016. The old system, which involved ‘grossing up’ net dividends via tax credits has been replaced by a system of fixed tax rates for the 2016/17 tax year onwards.
Important - You need to let HMRC know how much dividend income you have received via your annual self-assessment form.
2016/17 tax year onwards…
| Tax Band | 2017/18 Income | Tax Rate |
| Basic | £0 – £33,500 | 7.5% |
| Higher | £33,501 – £150,000 | 32.5% |
| Additional | £150,000 + | 38.1% |
A so-called £5000 ‘dividend allowance’ is also provided, which means the first £5,000 of dividends is not taxable. However, this allowance does not reduce the total income figure upon which you are taxed.
It is worth noting that, as announced during Spring Budget 2017, the £5000 allowance will be cut to £2000 from April 2018 onwards.
It’s important to remember that dividends are taxed after your other income sources have already been taxed, e.g. your salary and other relevant earnings from savings or investments. So, your dividends will fall into one or more of the tax bands listed above, after your personal allowance and other income sources have been added together.