Dividends and the Dividend Allowance Explained

Many contractors, freelancers and self-employed people choose to operate through a limited company. There are a lot of benefits to this business structure and flexibility in terms of remuneration and the tax advantages are key amongst those.

A tax-efficient remuneration strategy structures income in a way that minimises tax liability while remaining compliant and utilising dividends and the dividend allowance is an important part of this.

Self-employed people operating through a limited company should make sure they understand what dividends are, including the dividend allowance, to help maximise their earnings.

Dividends can be complex so read on for our guide on dividends, the dividend allowance, and how, as expert contractor accountants, we can help improve your tax-efficiency.

What Are Dividends?

Dividends are limited company profits that are distributed amongst Directors and Shareholders after corporation tax has been paid as a source of income and a reward for their investment into the business.

What is the Dividend Allowance?

A certain amount of the dividends you pay yourself are untaxed which is your annual dividend allowance. For the 2023/24 tax year the dividend allowance is £1,000. Your dividend allowance amount is unaffected by any other income sources you may have.

You can receive dividend payments tax-free covered by the personal allowance but the dividend allowance is in addition to your personal allowance of £12,570 in the 2023/24 tax year, meaning you can earn a maximum of £13,570 of untaxed income.

HMRC has unfortunately squeezed the dividend allowance in recent budgets and in the 2024/25 tax year it will halve (again!) to £500.

How do Dividend Payments Work?

Shareholders in a limited company can receive dividend payments based on the number of shares they own. If you’re a limited company contractor and the sole Shareholder in your business, you receive all dividends paid after tax. If there were two Shareholders, each with 50% of the shares they could receive half of any dividends issued but dividend payments can vary between Shareholders.

The amount of dividends paid cannot be more than the available retained profits in the business from either the current or previous financial year.

Before issuing any dividends, you must hold a Directors’ meeting to declare them. Minutes of the meeting must be kept even if you are the only Director and Shareholder in the business.

Every time you issue a dividend payment, a dividend voucher must be created to show the date, company name, names of the Shareholders receiving a dividend, the dividend amount paid and the signature of the director. Shareholders must get a copy of the voucher and a copy must be retained for the company’s records too.

How Are Dividends Taxed?

Although dividends over and above the dividend allowance are subject to tax, they are taxed at a lower rate than income tax on salary and this is an area where tax savings can be made. Unlike salary, dividends are not subject to National Insurance contributions. The company itself isn’t taxed on dividends paid, only the individual that receives them.

The rate of dividend tax payable depends on the amount of dividends received and your total income during the tax year. Dividends usually form the top slice of your income after considering other sources of income such as PAYE, rental income, and self-employment.

For the 2023/24 tax year the dividend tax bands and rates are:

  • Personal Allowance 0% – Up to £12,570
  • Basic Rate Taxpayers 8.75% – £12,571 – £50,270
  • Higher Rate Taxpayers 33.75% – £50,271 to £125,140
  • Additional Rate Taxpayers 39.35% – Over £125,140

When Can You Draw Dividends?

Dividends should only be withdrawn from the business when there is sufficient retained profit in the business to do so. They can be withdrawn at any time throughout the year and as many times as you like but it’s common practice to draw them quarterly or monthly.

If dividends are drawn when there’s insufficient retained profit, this can be considered illegal or a Director’s loan which must be repaid and might attract scrutiny from HMRC.

How Much Dividends Can You Draw?

To work out the amount of dividends you can draw from your business you need to establish your retained profit, also referred to as net profit. To do this you should deduct your expenses from your income. Expenses can include accountancy fees, software subscription, salaries and pension contributions. This will give you a gross profit figure.

Corporation tax is then chargeable on the gross profit then deducted which leaves you with a net profit after tax figure. This combined with any accumulated retained profits from previous accounting periods will provide you with the maximum amount that could be declared as a dividend.

You don’t have to draw all retained profit as dividends as profits can be kept in the business and used, for example, to fund growth or to contribute towards improved financial stability.

Working with Gorilla

When you appoint Gorilla, you receive market-leading FreeAgent accounting software free of charge inclusive in our great value, fixed monthly fees. FreeAgent has comprehensive automation features that make calculating your tax returns and reconciling your bank transactions a breeze and it can also show you how much retained profit you can take out and distribute in dividends.

We are expert limited company accountants and your own dedicated accountant will ensure that you utilise dividends to structure your remuneration in the most tax-efficient manner to maximise your earnings. All your business and personal accounting needs will be expertly managed with unlimited support and advice and slow turnaround times to your queries will never be an issue with Gorilla. Our Client Service Guarantee means you’ll receive a same working day response to any query sent to us before 3pm or we’ll issue you a £50 payment.

If you have any queries about the dividend allowance, dividends or our limited company accounting service, please call us today on 0330 024 0406 to speak to an accountant or request a callback here.