Dividends: everything you need to know

Dividends might seem straightforward on the surface, but the underlying mechanics are surprisingly complex.

Since they're strictly regulated under company law, getting them wrong can carry serious consequences, from repaying "illegal" dividends to potential director disqualification.

This guide breaks it all down. You'll learn exactly how dividends work, when they're appropriate, and how to manage them.

Our team, content and app can help you make informed decisions. However, any guidance and support should not be considered as 'legal, tax or financial advice.'

Contents

1. What are dividends?

2. When are companies able to pay dividends?

3. Who can receive dividends?

4. Who can't?

5. Use cases for dividends

   • Extract and distribute profits

   • Reward shareholders

   • Benefit investors

6. How are dividends taxed?

   • Tax rates 2025–26

   • Personal allowance

   • National Insurance

   • Self-assessment requirements

7. Dividends vs salary

   • Comparison chart

   • Employment Allowance

   • Finding a balance

8. The legal nuts and bolts of dividends

   • Distributable profits

   • Getting it wrong

   • Board resolutions

   • Dividend vouchers

   • Dividend record-keeping

9. Managing dividends with Vestd

10. FAQs

What are dividends anyway?  

Dividends are payments made from a company's profits to its shareholders, based on the number of shares they own. 

Here's a simplified example:

• Your company has built up £20,000 in retained profit – that’s after all expenses and Corporation Tax (CT) have been paid.
• If you own 100% of the shares, you could receive up to £20,000 as dividends.
• If you own 50%, your share would be £10,000.

However, this assumes all shareholders hold the same class of shares with identical dividend rights. In reality, companies often have multiple share classes with different entitlements.

Within each share class, dividends are paid proportionally based on the number of shares owned. But between different share classes, companies have much more control over who gets what.

Since dividends can only be paid from retained profits (profits accumulated since the company was founded, after all expenses and tax have been paid), your first dividend payment often marks a major milestone. It's proof that your business is profitable.

When are companies able to pay dividends?

Companies need to meet several conditions every time they want to pay dividends. These are specified under the Companies Act 2006 and must be satisfied without exception.

• Companies need sufficient distributable profits: Statutory accounts must show verified profits, not just cash position or recent trading performance. No profits on paper means no dividends.
  
  
• Companies must follow proper procedures: Board meetings, resolutions, minutes, vouchers – the law requires these every single time, not bureaucratic box-ticking that can be skipped when things get busy.
  
  
• Companies must stay solvent: The company must remain able to pay its debts after distributing the dividend. Directors must consider both current obligations and reasonably foreseeable future commitments.
  
  
• Companies must treat shareholders equally within share classes: Everyone holding the same class of shares gets the same rate per share. Companies can't decide to pay some shareholders more than others within the same share class.

The rules are in place to protect both shareholders and creditors, so they're enforced strictly. Non-compliance risks the dividend being classified as unlawful or “illegal”, which carries many potential consequences we’ll cover shortly.

Who can receive dividends?

First off, only shareholders can receive dividends. The key thing to understand is that dividend rights flow exclusively from legal share ownership, not from job titles, family relationships, or anything else.

If you're a director who also owns shares, you control both the timing and amount of dividend payments. 

Other shareholders – which could be anyone from team members who got shares through option schemes, to co-founders, external investors, or family members – receive their share of any dividends based on how many shares they own.

When multiple people hold shares, everyone is paid proportionally according to their shareholding within each share class.

On that note, ordinary, preference, and alphabet shares all work differently.

Who can’t receive dividends?

This one is simple, but there are two key requirements. If you don't own shares with dividend rights, you cannot receive dividends.

Any employees, directors, or those legally related to shareholders have no automatic right to dividend payments, unless they own shares in their own name that carry dividend entitlements. Even owning shares isn't enough if those shares don't have dividend rights attached to them.

So to receive dividends, you need both legal ownership of shares in your own name and those shares must be of a class that has dividend rights. Without both elements in place, dividend payments simply aren't possible under company law.

Dividends: use cases

Dividends can help shareholders unlock value created within the business and incentivise investors.

To extract and distribute profits

Dividends are one way to extract profits from a business, but they're not your only option. Let’s contextualise dividends alongside other options for extracting profits from your business. This makes their purpose much easier to understand:

• Salaries: A salary is a deductible business expense, reducing your company's CT liability. It faces both Income Tax and National Insurance (NI) contributions for the recipient, plus employer NI for the company.
  
  
• Bonuses are typically linked to performance or year-end results. Like salary, bonuses are deductible business expenses that reduce CT. They receive similar tax treatment as salary, including Income Tax and NI contributions.
  
  
• Pension contributions that a company makes into pension schemes on behalf of directors or employees. Another deductible business expense for the purpose of CT, and recipients receive tax relief on contributions.
  
  
• Benefits in kind are non-cash benefits your company provides, such as company cars, private health insurance, or gym memberships. Again, these are deductible business expenses for the company. Recipients face Income Tax (but not NI) on the taxable value of benefits received.

On the flip side, dividends are not deductible business expenses and face their own dividend tax rates with no NI contributions. And they can only be paid when your company has verified distributable profits and requires formal board procedures. 

In essence, dividends are one way to “convert” the business's profits into personal wealth for owners. By 'owner' we mean anyone who owns shares (though shareholders are always still paid within their respective share classes).

To reward shareholders

Dividends are also a way to reward anyone who owns shares in your business.

Of course, this only applies to people who actually own shares. If someone has share options, they won't see any dividends until they exercise those options and become proper shareholders. This can apply in the following situations:

• Enterprise Management Incentive (EMI) schemes let you grant tax-advantaged share options to employees. Once exercised, option holders become shareholders who may receive dividend payments, depending on whether their share class carries dividend rights and whether directors choose to declare dividends to that class.
  
  
• Growth shares give employees shares that only become valuable when a company reaches a specified valuation. However, dividend participation is typically more complex than with ordinary shares. Growth shares usually need to be unconditional (fully vested) before any dividends can be paid. 
  
  Even then, companies rarely green-light dividends on growth shares, as doing so could give the shares immediate value and potentially affect their tax treatment, since they're typically considered 'worthless' at the time of issue due to the hurdle price.
  
  
• Unapproved share options provide flexibility for incentivising key people who don't qualify for EMI schemes. Once exercised, these create shareholdings that may receive dividend payments, subject to the dividend rights of their share class and board approval.
  
  
• Direct share grants to advisors, consultants, or key contributors create ongoing dividend entitlements that align their interests with long-term business success.

In short, dividends can turn long-term, relatively illiquid equity into real-world value – without waiting for a sale or exit that may be years away (or never come)*. For many, it’s a way to share in the success they helped build – not just once at the end, but as the business grows.

*Many share schemes are exit-only, while others allow for earlier liquidity events or dividend participation. Check your scheme documents to see what applies to your specific setup.

Investment and ongoing returns

Investors provide capital in exchange for shareholdings, and dividends are one way they see returns on that investment while still holding their shares. Here’s how this tends to play out:

• Many investors, particularly those in profitable and established businesses, expect to see returns through dividends rather than waiting solely for exit events. This is especially true for investors in businesses that generate consistent profits.
  
  
• The decision to pay dividends to investors involves balancing their desire for returns against your company's need to retain profits for growth, working capital, and future opportunities.
  
  
• Once declared, dividend payments to investors carry the same legal obligations as any other dividend. They must be paid equally within each share class and in accordance with proper procedures.

Paying dividends out to investors is a huge accomplishment, as it indicates sufficient headroom to pay out profits rather than reinvesting them into the business!

How dividends are taxed

Dividends have their own tax framework. First, your company pays CT on its profits. Then, if there are “distributable profits” left over, they can be paid out as dividends to shareholders.

When someone receives a dividend, they’ll pay their own personal taxes on it, primarily based on the total income they’ve received during the year from all sources of income. 

Dividend tax rates for 2025–26

Everyone receives £500 of dividends tax-free each year for 2025–26 and the foreseeable future (this is called the Dividend Allowance).

This means the first £500 of dividend income you receive in the tax year is completely exempt from dividend tax, regardless of your other income.

Here are the rates you'll pay on dividend income above your £500 allowance:

• 8.75% for basic rate taxpayers (total income up to £50,270)
• 33.75% for higher-rate taxpayers (total income £50,271 to £125,140)
• 39.35% for additional rate taxpayers (total income above £125,140)

Your dividend income gets added to all your other income to determine which tax band you're in. So if you have a £45,000 salary plus £20,000 dividends, you're looking at £65,000 total income, pushing some of those dividends into the higher rate band.

Of course, take all of this with a pinch of salt as tax rates are subject to change! 

How dividends interact with your personal allowance

Your personal allowance (£12,570 as of 2025-2026) can also be applied against dividend income. 

If dividends are your only income, you can use your full £12,570 personal allowance against dividend income, plus your £500 dividend allowance, meaning you can receive up to £13,070 in dividends completely tax-free.

If you take a salary, your personal allowance gets used against that first. 

For example, if you take a £6,000 salary, you can use the remaining £6,570 of personal allowance against dividends, then your £500 dividend allowance kicks in for additional dividend income.

National Insurance

Dividends don’t incur NI contributions – either as an employee or an employer. This is one of the most significant tax advantages of dividends over salaries and comes into play when optimising your tax position.

Self-assessment requirements

Unlike salaries, where tax is deducted through the PAYE system, the dividend recipient is responsible for declaring dividend income and paying any tax due through the self-assessment system. Seek professional advice if you're unsure.

Our team, content and app can help you make informed decisions. However, any guidance and support should not be considered as 'legal, tax or financial advice.'

Dividends versus salary

With all that in mind, should you pay yourself a salary or take dividends as both a director and a shareholder? 

Truthfully, it’s not as easy to answer as it once was. Even a few years ago, dividends offered concrete advantages from a tax perspective. 

But things have changed. Tax rates have shuffled around, thresholds have moved, and new schemes have been introduced. Dividends and salary are now much closer in terms of tax efficiency than they used to be.

Key differences at a glance

Salary and dividends work through completely different tax systems, which is why comparing the two is tricky. Here’s what this looks like side-by-side:

At a high level, the trade-off is that salaries reduce your company’s CT bill, while dividends are taxed more lightly when someone receives them personally (though this is highly contingent on their personal income). 

The Employment Allowance (EA)

To complicate matters further, there’s another layer to the equation: Employment Allowance (EA). 

EA allows eligible businesses to reduce their employer NI bill by up to £10,500 per year. This is huge because it essentially removes the employer NI cost that normally makes low salaries more attractive than higher ones.

With EA, you can pay yourself a full £12,570 salary (matching your personal allowance) without any employer NI. No employer NI cost means a higher salary becomes much more tax-efficient – you get the corporation tax deduction on the salary without the NI penalty.

The problem? Most small business owners can't access EA. It's not available to sole director companies with no other employees. This exclusion affects the majority of small business owners and freelancers operating through limited companies.

Without EA, employer NI kicks in at £5,000. Once your salary exceeds the Secondary Threshold (£5,000 in 2025–26), your company pays 15% employer NI on everything above that amount. This cost is why many sole director companies keep salaries low – typically at or just below £5,000 – and extract the rest through dividends.

EA eligibility is the deciding factor. If you qualify for EA, paying yourself up to £12,570 becomes attractive because there's no employer NI cost. If you don't qualify, keeping salary low and using dividends often works out better overall.

The same tax rules, but completely different optimal strategies depending on one crucial factor: whether you have access to Employment Allowance.

Finding a balance between salary and dividends

Most business owners find a combination that works for their specific situation – typically some salary to cover certain needs, plus dividends for additional extraction when profits allow.

Broadly speaking, dividends tend to work well when you want:

• Flexibility in timing your income
• Tax efficiency on larger amounts
• Minimal paperwork compared to PAYE
• Variable income that reflects how your business is doing
• Strategic tax planning across multiple years

Salary tends to work well when you need:

• Documented income for things like mortgage applications
• Maximum pension contribution capacity
• State benefit entitlements
• NI records for your state pension
• Regular, predictable monthly income

There's no universal ‘best’ option. It depends on your company structure, how many people you employ, your profit levels, and what you need from your income.

The legal nuts and bolts of dividends

We've covered how dividends work and how they stack up versus other profit extraction methods. Now comes understanding the underlying mechanics. 

Dividends are strictly regulated to protect creditors from companies that might distribute money they can't afford to lose, and to ensure shareholders get treated fairly. 

Failing to meet obligations poses a risk to both the directors and the company. 

Directors may face personal liability, tax penalties, and even disqualification if they violate the rules, whether intentionally or unintentionally. 

Understanding distributable profits

Having money in the bank or making profits recently doesn't mean you can automatically pay dividends. You need something called distributable profits based on your statutory accounts.

Distributable profits are based on accumulated realised profits, minus any accumulated realised losses. These figures should appear in your company’s retained earnings on the balance sheet and reflect performance over time – not just in the current year.

Until the total profits made over time outweigh the total losses, you’re not legally allowed to pay dividends. The company must first clear the losses shown in its accounts.

This is why many growing companies that are doing spectacularly well today still can't pay dividends. They're still making up for losses from their early days. 

Getting it wrong

When dividends don't meet strict legal and financial conditions, they can be categorised as unlawful or illegal. Here are the most common ways dividends become illegal or unlawful:

• Not enough distributable profits: As we’ve just explained, if your total losses exceed your total profits, any dividend breaks the Companies Act 2006, regardless of how well you're trading or how much cash you have.
  
  
• Skipping proper procedures: Not holding board meetings, missing paperwork, or paying before you've formally declared them results in unlawful dividends.
  
  
• Wrong calculations: Using management accounts or estimates instead of proper statutory accounts is not allowed.
  
  
• Bad timing: Declaring dividends based on one set of accounts, then paying them after new losses wipe out your distributable profits, is also generally unlawful.
  
  
• Company can't afford it: You can't lawfully pay dividends if your company can't meet its debts afterwards.

Dividend non-compliance isn’t always the result of deliberate misuse. In many cases, directors genuinely believe they’re following the rules. But even honest mistakes can lead to serious consequences.

It’s important not to treat dividend payments casually, no matter how small the business.

Our team, content and app can help you make informed decisions. However, any guidance and support should not be considered as 'legal, tax or financial advice.'