What are dividends?

When you buy shares in a company, you become a part-owner. This means that you’re entitled to dividends — or a slice of the business’s profits — if the company decides to distribute them rather than reinvest them back into the business. But what are dividends? How are they paid? If you’re a business owner, can you pay them to yourself?

We’re here to answer all your questions. 

Firstly, what are dividends in business?

Dividends are cash payments that companies make to their shareholders. It’s how a company shares its success with the people who own a piece of it. The board might decide to make dividends available if the company has made a profit and has cash left over after covering expenses, paying debts, and setting aside money for future growth.

Companies aren’t legally required to pay dividends, though. And whether they decide to do so often depends on their size and strategy. Some rapidly growing businesses prefer to reinvest every penny back into expansion, while others (especially well-established firms) make regular dividend payments a critical part of how they appeal to investors. 

The amount you receive depends on how many shares you own and the dividend rate the company sets. If a company declares a dividend of 10p per share and you own 1,000 shares, you’ll receive £100. These payments typically happen quarterly or twice yearly, though some companies pay annual dividends.

Under what circumstances do shareholders get dividends?

In order for you to receive dividends, several key conditions need to align:

• The company must be profitable: Most importantly of all, the business needs to have made a profit before it can consider paying dividends. In the UK, companies can only legally distribute dividends from “distributable profits”. This is essentially the retained earnings from current and previous years. It’s designed to safeguard creditors by ensuring companies don’t pay out money they can’t afford to lose.
• The board decides to distribute profits: Even when profits exist, the board must actively choose to pay dividends rather than reinvest the money. This involves weighing up whether shareholders would benefit more from immediate income or from the company using those funds to fuel future growth. It’s worth being conscious of this as you go about your financial planning.

• The company has enough cash flow: Remember that profits on paper don’t always translate to available cash. A company might be profitable but have most of its money tied up in stock, equipment, or outstanding invoices. Dividends require actual cash, so companies need healthy cash flow to make dividend payments.

• You own shares on the right date: Timing matters enormously. You must own shares by the “ex-dividend date” to qualify for an upcoming payment. If you buy shares after this date, you’ll miss that particular dividend even if you own them when the payment is actually made.

Some companies have clear dividend policies in place that outline their intentions to pay consistent dividends even during lean periods. But others can be a lot more variable, with dividend payouts fluctuating dramatically depending on how the business is performing.

How are dividends paid on shares

In the UK, the dividend payment process follows a strict timeline that ensures all shareholders are treated fairly.

The dividend timeline

Once a company’s board approves a dividend, they announce it publicly along with three crucial dates:

• The record date determines which shareholders are eligible. You must be registered as a shareholder in the company’s books by this date. 
• The ex-dividend date falls one business day before the record date. Purchase shares before the ex-dividend date and you’ll receive the dividend. Buy afterwards and you won’t, even if you complete the purchase before the record date itself.
• The payment date is when the money actually reaches your account, typically several weeks after the record date to allow for some of the administrative work involved.

How the money reaches you

If you hold shares directly with the company or through a share dealing account, dividends are usually paid straight into your nominated bank account. Most online brokers and investment platforms handle this automatically. You’ll simply wake up to find the dividend payment in your account on the payment date.

If you hold shares through an ISA or a pension, the dividend typically gets reinvested or held as cash within your tax-wrapped account, depending on your preferences and your provider’s options.

You’ll also receive a dividend voucher or statement showing the gross dividend amount, any tax credits, and the net amount paid. Keep these records safe, as you’ll need them for your tax return if you’re liable for additional dividend tax. (Got more questions regarding tax on dividends? We’ll get there in a moment.)

A final word on currency conversations: for international shares, dividends are often paid in the company’s local currency, and then converted to pounds sterling by your broker. Be aware that the exchange rate on the conversion date will affect the final amount you receive, and you may face small conversion fees depending on your broker’s terms.

How to pay yourself dividends

If you’re a director or shareholder in your own limited company, paying yourself dividends can be one of the most tax-efficient ways of extracting profits from your business. However, it’s important that you understand the various rules and requirements involved so that you do this correctly and legally.

• For starters, you must have distributable profits. Before you can pay yourself any dividends, your company must have made a profit. As we mentioned above, this is called distributable profit, and it’s essentially your company’s retained earnings after corporation tax. This means you can’t pay dividends if your company is making a loss or if doing so would leave your company unable to pay its debts.
• Then, follow the proper legal process. Paying dividends isn’t as simple as transferring money from your business account to your personal one. Instead, you must follow specific procedures: hold a board meeting (even if you’re the sole director), pass a resolution to declare the dividend, and issue dividend vouchers to all shareholders. These vouchers must show the gross dividend amount, any associated tax credits, and your company details. Keep meticulous records. HMRC takes the dividend process seriously and may ask you for evidence.

• Consider your shareholding structure. If you own all the shares in your company, paying dividends is pretty straightforward. However, if you have business partners or other shareholders, dividends must be paid proportionally according to their shareholdings. You can’t pay yourself more than other shareholders if you all hold the same class of shares. This is illegal and could have serious consequences in terms of tax.

• Speaking of which, make sure you understand the tax implications. Unlike a salary, dividends don’t attract National Insurance contributions for either you or your company, which is why they can be tax-efficient. However, you’ll still pay dividend tax on amounts above the £1,000 annual allowance. Many directors take a small salary (often up to the National Insurance threshold) combined with dividends to make the most of their tax position.

• Finally, plan your timing carefully. You can declare dividends whenever your company has enough profits, but remember that the timing matters for tax planning. Consider spreading dividend payments across tax years to make the most of your annual allowances, and be aware that additional dividend income might push you into a higher tax bracket.

If you’re just learning about the dividend payment process, or if your financial situation has changed in any way, be sure to ask a qualified accountant for advice. They’ll be able to help you structure things so that they work in your best interest while being fully compliant with company law and tax regulations.

Do I pay tax on dividends?

OK, the tax question. Yes, you may need to pay tax on dividends in the UK — but only after a certain limit. Let’s take a look at how it works.

The dividend allowance 

Every UK taxpayer gets a dividend allowance of £500 per year (as of 2024–25), which means the first £500 of dividend income you receive is completely tax-free. This allowance is separate from your personal income tax allowance, so you can earn dividends tax-free even if you’re already using your full income tax allowance from employment or other sources.

Tax rates when you exceed the allowance 

Once your dividend income exceeds £500 in a tax year, you’ll pay tax on the excess at rates that depend on your overall income level. Basic-rate taxpayers (those earning up to £50,270, including dividends) pay 8.75% on dividend income above the allowance. Higher-rate taxpayers pay 33.75%, and additional-rate taxpayers (those earning over £125,140) pay 39.35%.

These rates are lower than income tax rates because dividends come from company profits that have already been subject to corporation tax.

HMRC has more information available here.

Reporting and paying the tax

If you owe dividend tax, you’ll need to declare it on a Self Assessment tax return, even if you don’t normally complete one. HMRC won’t automatically collect dividend tax through PAYE like they do with employment income. The tax is due by 31st January following the end of the tax year.

ISAs and pensions 

Dividends received within ISAs and pensions are completely tax-free, regardless of the amount. This makes these tax-wrapped accounts particularly attractive for dividend-focused investors, as you can build substantial dividend income without worrying about the tax implications.

Quickfire summary: what are dividends?

So, what is a dividend and how does it work? 

Dividends are cash payments that companies make to their shareholders as a way of sharing the profits from the business. Not all companies pay dividends, though, and they’re never guaranteed.

Understanding dividends is essential whether you’re investing in shares or running your own limited company. If you're a business owner interested in paying yourself dividends, remember that this process can be highly tax-efficient, but only if you follow the proper legal processes.

As always, seek out professional advice if you’re confused or if your situation changes at all. A qualified accountant will be able to help you maximise your income and ensure you’re operating in line with all the relevant laws and regulations.