Company Distributions and Dividends

Company distributions — most commonly dividends — are the way shareholders extract profits from a limited company. The distinction between a dividend and other types of distribution, such as a capital distribution (purchase of own shares) or a notional distribution (benefit or transfer at undervalue), has significant tax implications. For director-shareholders of small companies, the choice between taking income as salary or dividends is one of the most important tax planning decisions. This guide covers the different types of distribution, how they are taxed, and the record-keeping requirements.

Dividend vs Salary

Dividends are paid from post-tax profits of the company — the company does not receive a tax deduction for dividends paid. Salary, on the other hand, is a deductible expense that reduces the company's Corporation Tax liability. However, salary attracts Income Tax and National Insurance (both employee and employer), while dividends are subject to Income Tax only (no NIC). For a basic-rate taxpayer, dividends up to the dividend allowance (£500 in 2025/26) are tax-free, and dividends above that are taxed at 8.75% — significantly less than the combined Income Tax and NIC on salary. For higher-rate taxpayers, the dividend rate is 33.75%, and for additional-rate taxpayers it is 39.35%. The optimal mix depends on your company's profits, your personal tax position, your pension contributions, and whether you need to retain profits for reinvestment. Most small company directors pay themselves a salary of around £9,100 (the NIC secondary threshold) to preserve qualifying years for State Pension without incurring employer NIC, then extract remaining profits as dividends.

Tax on Dividends

Dividends received by individuals are taxed at the following rates for 2025/26: the first £500 of dividend income is taxed at 0% (the dividend allowance), dividends within the basic rate band (£12,571 to £50,270) are taxed at 8.75%, dividends within the higher rate band (£50,271 to £125,140) are taxed at 33.75%, and dividends above £125,140 are taxed at 39.35%. Dividends are treated as the top slice of income — they are deemed to sit above all other income, meaning they use up the basic and higher rate bands after salary, savings, and other income. The dividend allowance is a nil-rate band, not a tax-free allowance — if you have dividend income of £600, only the first £500 benefits from the 0% rate; the remaining £100 is taxed at the appropriate dividend rate. Dividends received from UK companies are paid without tax deducted — you report them on your Self Assessment return and pay any tax due through the normal balancing payment process.

Notional Distributions

A notional distribution arises where a close company provides a benefit or transfers an asset to a participator at undervalue. The excess of the market value over the amount paid (if any) is treated as a distribution. Common examples include: a company sells an asset to a shareholder at less than market value, a company pays a shareholder's personal expenses, or a company provides a benefit to a shareholder who is not an employee (and therefore not subject to P11D reporting). Notional distributions are treated as dividends for tax purposes — the company receives no deduction, and the shareholder is taxed at dividend rates on the notional amount. This is a common issue where a director uses company funds to pay personal legal fees, school fees, or holiday costs without declaring the benefit.

Capital Distributions — Purchase of Own Shares

When a company purchases its own shares from a shareholder, the payment may be treated as a capital distribution rather than as a dividend. If the purchase is for the benefit of the company's trade (for example, to remove a shareholder who is leaving the business) and certain conditions are met, the distribution is treated as a capital gain rather than a dividend. The shareholder may then be entitled to Entrepreneurs' Relief (Business Asset Disposal Relief), which taxes gains at 10% — a significant saving compared with dividend tax rates. The conditions include: the company must be unquoted (or listed on AIM), the shareholder must have owned the shares for at least five years, the purchase must be to benefit the trade, and the shareholder must reduce their shareholding by more than 25%. The company must also stamp and cancel the purchased shares. Capital distributions are reported on the shareholder's Self Assessment capital gains pages, not the dividend pages.

Distribution Waivers

A shareholder can waive their right to receive a dividend by signing a deed of waiver. This is commonly used in family companies where one shareholder (often the main earner) waives their dividend in favour of another shareholder (such as a spouse) who is in a lower tax bracket. However, HMRC may apply the settlements legislation to reallocate the dividend back to the waiving shareholder if the waiver is not commercially justified or if the arrangement is considered a settlement of income. For the waiver to be effective, it must be executed before the dividend is declared, must be in writing, and must be irrevocable. A shareholder cannot waive a dividend after the dividend has been declared — at that point, the right to the dividend has crystallised.

Dividend Vouchers and Record-Keeping

Every dividend payment must be supported by a dividend voucher (sometimes called a dividend certificate). The voucher must show: the company name and registered number, the date of the dividend, the shareholder's name, the amount of the dividend per share and in total, the type of dividend (interim or final), and the tax credit (if applicable). For dividends paid after 6 April 2016, there is no notional tax credit — the voucher simply records the amount received. The company must keep copies of all dividend vouchers and board minutes authorising the dividend. For a final dividend, the shareholders must vote to approve it at a general meeting (or by written resolution). For an interim dividend, the board alone can authorise it. The company must ensure that it has sufficient distributable reserves (retained profits) to pay the dividend — paying a dividend out of capital is unlawful and can result in director liability.

Explore more UK business and employer guides or try our calculators.