What are dividends and how are they taxed?

If you’re setting up a small business you’ll no longer be on someone else’s payroll, so you will need to understand how to extract money from your company. Unfortunately, it’s not a case of helping yourself to whatever’s in the bank.
You’ll need to work out what expenses you have to cover, what tax you owe and what profit your company has made. Then you can look at the most tax-efficient way to pay yourself.

For most small business owners, the best solution is a mixture of salary and dividend, whereby you take your tax-free personal allowance as salary and the rest of your income as a dividend. There are certain rules you have to abide by when calculating and taking dividends, however. Here we explain how dividends work.

What are dividends?

If your company has made a profit, it can distribute the money, known as ‘retained income’, to shareholders via dividend payments. In many small businesses, the owner will be the sole shareholder, but if you have other shareholders then dividends should be distributed according to the percentage of company shares owned by each shareholder.

Dividends are based on profits after business expenses and tax liabilities have been paid and are a tax-efficient way to pay yourself because, unlike a salary, they do not attract National Insurance Contributions (NICs).

It’s important to note that dividends can only be paid if the company has made a profit. This means you must account for tax liabilities and expenses before you take dividends out of the business. If you take money from your business as a dividend which exceeds the amount of profit it holds, the payments you receive are known as illegal dividends and could land you into trouble with HMRC.

From an accounting point of view, the over-payment of dividends is classed as an ‘overdrawn director’s loan’, this normally needs to be paid back to the company within 9 months of the year-end, or interest and additional tax may be due.
It’s important to note that you do not have to take all of your profit out of your business at the end of each financial year.

You can accumulate your retained profit and leave it in your business bank account for future use. This can be a helpful way to manage your income, and work tax efficiently, if you’re planning to take a break from work or if your available work reduces and you think you may earn less in the following financial year.

Illegal dividends

How dividend tax is calculated?

Dividend tax is paid via the annual self-assessment tax return process so is included in the mix of your overall income from investments and interest. Each shareholder will benefit from a £500 dividend allowance for the year ended 5th April 2025, reduced from £1,000 in the year ended 5th April 2024 and £2,000 prior to this. This means that for the year ended 5th April 2025, the first £500 in dividends is tax-free. The remaining dividend payments are taxed depending on which tax band they fall in above the personal allowance, the tax bands are as follows:

Tax Band	2024/25 & 2023/24	2022/23	Tax Rate
Basic	£0 - £37,700	£0 - £37,700	8.75%
Higher	£37,701 to £125,140	£37,701 to £150,000	33.75%
Additional	Over £125,140	Over £150,000	39.35%

Dividend tax example (2024/25)

The following example is based on a company shareholder who wishes to take a £50,000 dividend based on 2024/25 profits when they have been paid a salary of £9,096.

The first £12,570 of income is tax-free (the personal allowance).
The first £500 of dividends is tax-free (the dividend allowance).
The next £37,200 of dividends are taxed at the basic dividend rate (8.75%) = £3,255.00.
The final £8,826 of dividends are taxed at a higher dividend rate (33.75%) = £2,978.78.
Total dividend tax payable is £6,233.78.‍

‍(To avoid paying higher rate tax, it would be recommended that the company shareholder restricts his dividends to £41,174.00)

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The following example is based on a company shareholder who wishes to take a £50,000 dividend based on 2024/25 profits when they have been paid a salary of £12,570.

The first £12,570 of income is tax-free (the personal allowance).
The first £500 of dividends is tax-free (the dividend allowance).
The next £37,200 of dividends are taxed at the basic dividend rate (8.75%) = £3,255.00.
The final £12,300 of dividends are taxed at a higher dividend rate (33.75%) = £4,151.25.
Total dividend tax payable is £7,406.25.

(To avoid paying higher rate tax, it would be recommended that the company shareholder restricts his dividends to £37,700.00)

Dividend tax example (2023/24)

The following example is based on a company shareholder who wishes to take a £50,000 dividend based on 2023/24 profits when they have been paid a salary of £9,096.

The first £12,570 of income is tax-free (the personal allowance).
The first £1,000 of dividends is tax-free (the dividend allowance).
The next £36,700 of dividends are taxed at the basic dividend rate (8.75%) = £3,211.25.
The final £8,826 of dividends are taxed at a higher dividend rate (33.75%) = £2,978.78.
Total dividend tax payable is £6,190.03.

(To avoid paying higher rate tax, it would be recommended that the company shareholder restricts his dividends to £41,174.00)

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The following example is based on a company shareholder who wishes to take a £50,000 dividend based on 2023/24 profits when they have been paid a salary of £12,570.

The first £12,570 of income is tax-free (the personal allowance).
The first £1,000 of dividends is tax-free (the dividend allowance).
The next £36,700 of dividends are taxed at the basic dividend rate (8.75%) = £3,211.25.
The final £12,300 of dividends are taxed at a higher dividend rate (33.75%) = £4,151.25.
Total dividend tax payable is £7,362.50.

(To avoid paying higher rate tax, it would be recommended that the company shareholder restricts his dividends to £37,700.00)

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Dividend tax example (2022/23)

The following example is based on a company shareholder who wishes to take a £50,000 dividend based on 2022/23 profits when they have been paid a salary of £9,096.

The first £12,570 of income is tax-free (the personal allowance).
The first £2,000 of dividends is tax-free (the dividend allowance).
The next £35,700 of dividends are taxed at the basic dividend rate (8.75%) = £3,123.75.
The final £8,826 of dividends are taxed at a higher dividend rate (33.75%) = £2,978.78.
Total dividend tax payable is £6,102.53

(To avoid paying higher rate tax, it would be recommended that the company shareholder restricts his dividends to £41,174.00)

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The following example is based on a company shareholder who wishes to take a £50,000 dividend based on 2022/23 profits when they have been paid a salary of £12,570.

The first £12,570 of income is tax-free (the personal allowance).
The first £2,000 of dividends is tax-free (the dividend allowance).
The next £35,700 of dividends are taxed at the basic dividend rate (8.75%) = £3,123.75.
The final £12,300 of dividends are taxed at a higher dividend rate (33.75%) = £4,151.25.
Total dividend tax payable is £7,275.00.

(To avoid paying higher rate tax, it would be recommended that the company shareholder restricts his dividends to £37,700.00)

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Unlike Corporation Tax, dividend tax should be made from your personal bank account by January 31st each year, the deadline for all self-assessment tax payments.

Administration of dividends

One of the key benefits of working for yourself is the ability to pay yourself whenever you like. Don’t forget, as long as your company has a profit, you can take a dividend. Here’s how it works:

Your company must hold a board meeting to agree on the distribution of dividends. If you are the only shareholder, this is, of course, a formality.
When you’re ready to take a dividend, you simply prepare a ‘dividend voucher’, a basic record which details:

The date the dividend is paid.
Your company name.
The name and address of the recipient.
The total number of shares owned by the shareholder.
The total dividend payable to the shareholder.
The director’s signature.

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