Dividends – What are they and how do I take them?

 

Taking money out of your company isn’t as simple as a quick bank transfer. If you want to stay on the right side of HMRC, dividends require a specific procedure. If you run a limited company, dividends are one of the most tax-efficient ways to pay yourself. But they come with strict rules—and getting them wrong can lead to unexpected tax bills and unnecessary compliance issues.

In this guide, we’ll walk you through exactly what dividends are, how they work, and the best practices to keep your books compliant.

 

What Are Dividends?

Dividends are payments made by a limited company to its shareholders from post-tax profits.

In simple terms:

• Your company makes a profit
• It sets aside funds for Corporation Tax
• The remaining profit (distributable reserves) can be distributed as dividends

If you are both a director and shareholder (which is common for small business owners), dividends are usually taken alongside a salary.

 

How Dividends Work (A Simple Example)

Let’s say your company:

• Makes £50,000 profit
• Pays £9,500 Corporation Tax (at an example 19% rate)
• Has £40,500 remaining

That £40,500 is available for dividends — provided the company doesn’t have any brought-forward losses from previous years.

 

The Golden Rules of Dividend Compliance

Dividends are not as flexible as just “taking money out of the business.”

To keep things legal and compliant, you must follow these requirements:

 

1. Profits are Mandatory:

You must have sufficient retained profits (also called distributable reserves).

If you pay dividends without profits:

• They are considered illegal dividends
• HMRC may treat them as salary or a director’s loan
• This can trigger unexpected tax and penalties

 

2. The Paperwork Matters:

Every dividend payment must be supported by:

• A board meeting minute (even if you’re the sole director)
• A dividend voucher for each shareholder

 

3. Dividends Must Be Proportionate

Dividends must be paid according to shareholdings.

Example:

• You own 70% of shares → receive 70% of dividends
• Another shareholder owns 30% → receives 30%

You cannot arbitrarily decide different amounts unless you have different classes of shares.

 

4. Record Keeping Is Essential

You should always keep:

• Up-to-date management accounts
• Dividend vouchers
• Board minutes
• A clear audit trail of payments

Poor record keeping is one of the most common issues we see during HMRC enquiries.

 

5. Dividend Tax Still Applies

Although dividends are tax-efficient, they are not tax-free.

You will:

• Have a tax-free dividend allowance (subject to change each tax year)
• Anything above that is taxed at your applicable dividend tax rate (Basic, Higher, or Additional).

This is why planning your salary and dividends together is important.

 

Best Practices for Taking Dividends

Here’s how to stay on the safe side and make the most of your income:

 

✔ Check Profits Before Every Dividend

Don’t rely on your bank balance — always check your actual profit and balance sheet position, as your bank balance doesn’t account for VAT or Corporation Tax.

 

✔ Take Dividends Regularly (If Appropriate)

Quarterly dividends can help:

• Smooth personal income
• Avoid large, risky year-end withdrawals

 

✔ Combine Salary and Dividends Efficiently

A small salary plus dividends is often the most tax-efficient structure — but this should be reviewed annually.

 

✔ Avoid “Backdating” Dividends

Dividends should be declared before or at the time they are paid, not after.

 

✔ Keep Everything Documented

Even if you’re a one-person company, paperwork still matters. It protects you if HMRC ever asks questions.

 

Common Mistakes to Avoid

• Taking dividends when the company has no profits
• Not preparing dividend vouchers
• Treating dividends like a casual withdrawal
• Ignoring personal tax implications
• Poor or missing documentation