When running your own limited company, taking dividends is one of the main routes available to you that enables accessibility to cash for personal use. Unlike operating as a sole trader, any earnings made by the company legally belong to the company itself as its own legal entity.
Read our previous blog for full details on differences between sole traders and limited companies, as well as the advantages of both.
Here, we will explain the basics around dividends including how often you can take dividends and the advantages of doing so. A full breakdown on taking dividends can be found on the Gov.uk website.
What is a dividend?
A dividend is a payment a company can make to its shareholders out of its profits. Cash dividends are arguably the most common form of dividends and will be the focus of this article, and involve the distribution of cash from a limited company to its eligible shareholders.
As an owner of a limited company, you hold a dual status as shareholder and employee (employed as a director), and this entitles you to dividends because of the shareholder role, but also a salary because of the employee status.
Dividends are not tax-deductible and can only be issued once all the company’s liabilities have been accounted for.
When can you take out dividends?
Directors have the power to decide when to take out dividends at any time, with no formal rule regarding the timing of releasing these payments. There is however, one condition that must be met, which is that there has to be sufficient profit in order to do so.
By the end of your company’s financial year, any dividends that have been issued must be covered by profits earned in that year- after expenses and liabilities have been paid. If the company is loss making, with no available reserves, it is illegal to pay out dividends in these circumstances.
How often can you take out dividends?
Dividends can be taken out at the discretion of the directors as stated above, as long as the condition outlined is met – the company has the reserves to do so. It is important to note that taking out dividends too often may alert HMRC to the potential practice of disguised salaries and may lead to an investigation.
Advantages of taking out dividends
Taking dividends is typically recommended as part of an effective tax planning strategy. Advantages of doing so include:
- Lower tax rate than income tax, which is applied to salaries.
- No National Insurance contribution is paid on dividends.
- Regularly paying dividends can help attract investment.
- An effective salary/dividend/Pension strategy can save you lot of tax. Directors need to ensure they take advice and utilise their tax-free allowance where relevant by also taking a salary.
Disadvantages of taking out dividends
Many limited companies purposefully choose not to issue dividend payments, and reasons for this include:
- Additional administrative responsibilities in order to take out dividends.
- Funds issues as dividends means that less money can be used to invest in the company.
- Dividends do not count as relevant UK earnings in relation to tax relief on pension contributions.
Get help with taking out dividends
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