Paying dividends, the act of making either cash or non-monetary payments to shareholders, is part of the normal process for many businesses. However, there are some conditions around who can pay dividends and who can accept them, as well as rules around the payment itself. To make sure you know all about how to comply with the laws on dividends, read our guide to paying dividends below.
What is a dividend?
Dividends are typically cash payments made to shareholders of limited companies out of annual profits. Dividends can also be non-monetary, for example dividends of property or shares.
Because dividends must be made out of profits (the funds remaining after a company has paid all its outstanding business expenses and taxes), it’s unlawful for you to pay a dividend if there wouldn’t be enough cash remaining in the company after the distribution has been made to pay existing or upcoming debts. In addition, companies that have accumulated losses cannot pay a dividend.
Certain companies, such as public limited companies, investment companies and insurance companies, are subject to further restrictions in regard to their ability to pay dividends.
A company does not have to pay dividends. Instead, it can choose to accumulate its profits as working capital, or to invest or pay dividends at a later date. These are known as ‘retained earnings’.
In large companies, dividends are usually paid annually, and are declared by the shareholders at the company’s Annual General Meeting. This is so that the directors can ensure that the company has sufficient available funds based on the annual accounts that are also approved at the AGM.
A company may also pay interim dividends throughout the year if it is confident that profits are sufficient to meet ongoing expenses. Smaller, private limited companies often use this method to pay directors, as this can be more tax-efficient than the payment of a salary, because National Insurance is not payable on dividends.
Once a dividend has been declared by the shareholders, it becomes a debt due and payable by the company.
Dividends can be paid in any currency, and are usually made by bank transfer. If you want to specify the types of currency, or set out rules for methods of payment in regards to dividends, a company can make specifications in the Articles of Association.
Who can take a dividend?
The shareholders of a company who appear in the register of members are usually entitled to receive dividends on an equal basis. If the company has created different classes of shares, however, then certain shareholders may not be entitled to dividends, or have enhanced rights to dividends.
If there are a lot of shareholders, or if the company is a public company, it may fix a date known as a ‘record date’ to establish which shareholders can receive a dividend.
Rules for paying dividends
If you are a company director, then you have a legal duty to protect the company’s assets and to carefully consider whether you have sufficient funds to pay its liabilities (for example, upcoming VAT and corporation tax payments) before you declare or recommend that a dividend be paid. If you want to continue to pay dividends even during periods when cash-flow is tight, you can set up reserves from profits so that you can even out your dividend payments throughout the year, or from year to year.
While there are no criminal penalties that attach to unlawful dividend payments, you may become personally liable to repay the company if you pay a dividend when the company hasn’t got sufficient funds. You may also be liable under insolvency law if you pay a dividend when the company is insolvent, or subsequently becomes insolvent, because it is unlawful to pay dividends as a means to avoid satisfying the demands of creditors.
Paying dividends: the process
Declaring a dividend is a formal process, for which you must keep a record. Dividends are usually accompanied by a dividend ‘voucher’, which records:
- The date of the dividend.
- The name of the company.
- The identity of the shareholder.
- The dividend amount.
Unless you have issued different classes of shares with varying rights to dividends, shareholders are normally entitled to dividends according to the number of fully paid-up shares they own, a right will be described in the Articles.
Before declaring or recommending that the shareholders declare a dividend payment, you should check the Articles for any restrictions that may apply to dividend payments. The Articles usually state that no interest is payable on outstanding dividends.
The Articles may state that while directors recommend the final dividend, it’s the company’s shareholders that make the formal declaration, and this can either be at the AGM or by a written resolution. However, the dividend can’t be in excess of the amount recommended by the directors. The Articles may also provide that directors acting alone can declare interim dividends. If the members have entered into a shareholders’ agreement, you should also check its terms to ensure that there are no other rules or restrictions on the payment of dividends.
If the Articles don’t contain any restrictions, then the directors can declare both interim and final dividends, although it’s standard practice that the final dividend at least is declared by the shareholders at the AGM, particularly if the company is listed.
In order to calculate what dividend you can pay, you need to consider the company’s current trading position, and whether the company will retain enough cash after the dividend has been paid to meet debts that are currently (or will shortly become) due.
To figure out how much dividend to pay each shareholder where there are classes of shares that relate to dividend payments (generally called ‘preference shares’), you will need to be aware of any premiums that may be payable on outstanding shares, and any other provisions that curtail shareholders’ rights to receive dividends.
If you own a small company of which you are also a director, and you want to retain cash in the business, or avoid paying a dividend in order to reduce your taxable income, you can decide to waive a dividend by executing a deed of waiver. This must be signed, dated, witnessed and sent to the company. Usually the company’s Articles provide that for a dividend waiver to be effective, all persons entitled to the share (for example if there are joint shareholders) must sign the waiver.
You can’t use a waiver to avoid paying certain shareholders a dividend; if you want to create a class of shareholders that are not entitled to dividends, you must create different classes of shares.
You should also be careful not to use waivers as a means to divert funds from higher to lower rate taxpayers, particularly if you run a small company, as this can be deemed a ‘settlement’ by HMRC. In addition, waivers that last for more than a year can lead to a charge to inheritance tax if this is applicable.
You must normally waive your right to an interim dividend before it is paid, and your right to a final dividend before it has been approved by the shareholders. When the dividend is waived, the company will either keep the amount that has been waived, or pay it out to shareholders in relation to their shareholdings.
Taxation when paying dividends
Dividends are taxable in the hands of the shareholders, but are not subject to National Insurance Contributions either by the company or the recipients. If you have a small company, then it can be tax-efficient to take a small salary and the remainder of your pay in dividends. Currently (2019/20 tax year), you can earn up to £2,000 in dividends tax free, in addition to your Personal Allowance for income tax. After this amount, dividends are taxed at a lower and a higher rate, depending on the amount of the dividend and the tax bracket you fall into.