How to Pay Dividends Correctly From Your Limited Company

What a Dividend Actually Is

A dividend is a payment a company makes to its shareholders out of profit that is available for distribution. It is a return on their shares, and it must be paid in proportion to shareholdings. As gov.uk puts it, you must usually pay dividends to all shareholders, so if two people each own half the company, they each receive half of any dividend declared.

This is the key distinction between a dividend and other money you might move out of the business. Salary is paid to you as an employee or director through payroll. A director's loan is money you borrow from the company and are expected to repay. A dividend is your share of the profits the company has actually made after Corporation Tax. Because a dividend depends on real, retained profit, you cannot simply pay yourself a dividend whenever the bank balance looks healthy.

The rules that govern dividends sit in the Companies Act 2006. Part 23 covers distributions, and it sets out when a company is allowed to make one, how the decision must be justified by reference to accounts, and what happens if a distribution is unlawful. Understanding those rules is what separates a correct dividend from a risky one.

You Can Only Pay Dividends From Distributable Profits

The single most important rule is that dividends must come from profit, not from turnover or cash in the bank. Section 830 of the Companies Act 2006 states that a company may only make a distribution out of profits available for the purpose. Those profits are defined as the company's accumulated, realised profits, so far as not previously used by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off.

In plain terms, that means you add up the profits the company has genuinely made and kept over its lifetime, subtract any losses and any profits already paid out, and what remains is what you can distribute. gov.uk reinforces this by warning that your company must not pay out more in dividends than its available profits from current and previous financial years.

Section 836 says that whether a distribution is lawful is judged by reference to the relevant accounts, normally the company's last annual accounts. If your business is newly formed or wants to declare a dividend before its first set of accounts, it may need to prepare interim or initial accounts to show the profit is really there. If you distribute more than the available profit, the payment can be an unlawful distribution, and under section 847 a shareholder who knew, or had reasonable grounds to believe, the dividend was unlawful can be required to repay it to the company.

The Correct Steps to Declare and Pay a Dividend

Once you are confident there is enough distributable profit, the process itself is straightforward, but each step matters. gov.uk requires that to pay a dividend you hold a directors' meeting to declare the dividend and keep minutes of that meeting, even if you are the only director. You must also prepare a dividend voucher for each payment.

Doing these steps in order, and keeping the paperwork, is what makes the dividend defensible if HMRC or an accountant later reviews it. Treat the sequence below as a routine you repeat every time you take a dividend.

Board Minutes and Dividend Vouchers

The board minutes are the record that the dividend was properly declared. They should note the date of the meeting, who attended, the amount being declared, the rate per share and the date the dividend will be paid. Even a sole director must produce them, because they demonstrate that the distribution was a deliberate, documented decision rather than an informal withdrawal.

A dividend voucher is the document each shareholder receives to confirm what they were paid. According to gov.uk, the voucher must show the date, the company name, the names of the shareholders being paid a dividend, and the amount of the dividend. You give a copy to each recipient and keep a copy for the company's records.

These documents are not bureaucracy for its own sake. If there is ever a dispute, an HMRC enquiry, or a question about whether a payment was really a dividend or a hidden salary or loan, the minutes and vouchers are your evidence. Storing them alongside your accounts each year keeps the trail clean and makes your Self Assessment reporting far simpler.

Dividend Tax: Allowance and Rates for 2026 to 2027

The company pays no additional tax when it distributes a dividend, because dividends come out of profit that has already been subject to Corporation Tax. The tax falls on the shareholder instead, through Self Assessment. You do not pay tax on dividend income that falls within your Personal Allowance, which is £12,570, and on top of that everyone gets a dividend allowance of £500 each year, meaning the first £500 of dividends above the Personal Allowance is taxed at 0 per cent.

Above the allowance, the rate you pay depends on your income tax band. To work out your band, add your total dividend income to your other income; you may pay tax at more than one rate. For the tax year 6 April 2026 to 5 April 2027, dividends are taxed at 10.75 per cent within the basic rate band, 35.75 per cent within the higher rate band and 39.35 per cent within the additional rate band. The basic and higher rates rose from 6 April 2026, while the additional rate stayed the same.

For example, if you have £29,570 of wages and take £3,000 in dividends, your total income is £32,570. After the £12,570 Personal Allowance and the £500 dividend allowance, the remaining dividend income sits in the basic rate band and is taxed at 10.75 per cent. Planning the size and timing of dividends around these bands is where much of the tax efficiency comes from.

Dividends Versus Salary

Many director-shareholders take a mix of a modest salary and dividends. The two are taxed very differently. Salary is paid through PAYE and is subject to Income Tax and National Insurance, but it is a deductible business expense that reduces the company's Corporation Tax bill. Dividends are not a business expense; they are paid from profit after Corporation Tax, carry no National Insurance, and are taxed at the dividend rates rather than the main Income Tax rates.

That is why dividends are often more tax-efficient than an equivalent amount of salary, particularly once you factor in National Insurance. The trade-off is that dividends depend on the company being profitable, and only shareholders can receive them. A common approach is a small salary that makes use of allowances and preserves your National Insurance record, topped up with dividends from profit. The right balance depends on your personal circumstances, so it is worth taking advice rather than copying a generic formula.

Whatever split you choose, keep the two clearly separate in your records. Salary runs through payroll with its own paperwork; dividends need board minutes and vouchers. Blurring the line, for instance calling a regular monthly withdrawal a dividend without the supporting documents or profit to back it, is exactly the kind of practice that leads to problems.

The Danger of Unlawful Dividends

An unlawful, or illegal, dividend is one paid when the company did not have enough distributable profit, or one that was not properly declared and documented. This is a real risk for small companies, especially where a director draws money throughout the year and only later discovers the profit was not there to support it. Because the payment breaches Part 23 of the Companies Act 2006, it can be challenged.

Under section 847, if a shareholder receives a distribution made in breach of Part 23 and knows, or has reasonable grounds for believing, that it was made unlawfully, they must repay it to the company. For an owner-director, who typically both approves and receives the dividend, that knowledge is hard to deny. An unlawful dividend can also be reclassified for tax purposes, potentially as a director's loan, which brings its own tax consequences.

The way to avoid all of this is discipline rather than luck. Check distributable profits before you declare anything, hold the meeting and keep minutes, issue the voucher, and only pay out what the accounts support. If profit is uncertain during the year, it is safer to draw a smaller salary or take a director's loan and formalise dividends once the figures are clear.

Conclusion

Paying dividends correctly comes down to a repeatable routine: confirm you have distributable profits, hold a directors' meeting and keep minutes, issue a dividend voucher to each shareholder, and report the income on Self Assessment. Follow that sequence every time and your dividends are both lawful under the Companies Act 2006 and clean for HMRC. Skip a step, or pay out more than your profits allow, and a convenient tax-efficient payment can turn into an unlawful distribution you may have to repay.

The rules are not difficult, but they reward good habits and accurate records. If you are setting up a company or want a clean structure for taking money out from day one, our company formation service helps you start on the right footing, and you can always contact our team if you want to talk through salary and dividend planning for your situation. Where the tax position is finely balanced, a short conversation with an accountant is time well spent.

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