What is a dividend?

Definition of a dividend

A dividend is a sum of money that a limited company pays out to someone who owns shares in the company, i.e. a shareholder.

Only limited companies can pay dividends, because they are the only type of business that issues shares. Sole traders, partnerships and LLPs can't pay dividends, because they do not issue shares.

Limited companies are only allowed to pay dividends if they have enough profit available to do so - and the dividend payment comes out of profit after corporation tax. Even if the company has enough cash to pay the dividend, it is illegal for the dividend to be paid if there is no available profit.

The profit that the dividend is paid from can be from this current year, or from a previous year, but the directors must have a board meeting to check that there is enough profit available before they allow a dividend to be paid. Permitting a dividend to be paid is called 'declaring' a dividend.

Any declaration of dividends must be recorded as a board minute.

How dividends work:

A small company makes a profit of £1,000 in the current year. It also has profit saved up of £5,000 from previous years, on which corporation tax has already been paid.

Allowing for 20% corporation tax on the current year's profit (£1,000 * 20% = £200 corporation tax), the company can pay a maximum of £5,800 in dividends to shareholders.

Frequently Asked Questions

I am the only director and shareholder in a company. Do I have to have a meeting with myself to check that there is sufficient profit to pay a dividend?

Strictly speaking, yes! You must still check your accounts to make sure the company has enough profit available to pay the dividend, and minute that you have run this check.

Are dividends exempt from tax?

As dividends are income, they are liable for tax; however, dividends are taxed at a different rate from most other types of income.

Got questions? Ask Emily!

FreeAgent's Chief Accountant Emily Coltman is available to answer your questions in the comments.

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