What Is a Dividend?
A dividend is a payment a company makes to its shareholders out of its profits. When a limited company has made money, paid its corporation tax and decided it does not need to keep all of what is left, it can hand some of that profit back to the people who own it. That payment is a dividend.
The word gets used loosely, so it helps to be precise. A dividend is a return on your shares, not a reward for the work you do. If you own a slice of a company, you get a slice of the distributed profit, in proportion to how many shares you hold. A salary is paid for your labour and runs through payroll. A dividend is paid for your ownership and never touches payroll. That distinction sits behind almost everything else in this guide.
For most people in the UK, dividends turn up in one of two ways. Either you hold shares in listed companies through an investment account or pension and receive small payments a few times a year, or you run your own limited company and pay yourself dividends on top of a modest salary. The mechanics are the same in both cases. The tax, and the amount of care needed, tends to differ.
How Do Dividends Work?
A dividend can only be paid out of profit the company is actually allowed to distribute. Under the Companies Act 2006 that means accumulated, realised profits, after corporation tax, less any losses brought forward. In plain terms, a company can only pay dividends from its retained earnings, the running pot of profit it has kept rather than already paid out. If there is no profit to distribute, there is no lawful dividend, however much cash happens to be sitting in the bank.
Assuming the profit is there, the process runs roughly like this:
- The directors check the numbers. Before declaring anything, they need to be satisfied that distributable reserves cover the payment. This is best supported by up to date management figures, not a guess.
- The dividend is declared. Final dividends are usually approved by the shareholders at the year end. Interim dividends can be declared by the directors during the year. Either way it should be minuted.
- A dividend voucher is issued. Each shareholder receives a voucher showing the date, the company name, the shareholder and the amount. This is the paperwork HMRC expects to see if it ever asks.
- The money is paid. The dividend is split according to shareholdings. Someone holding 60 percent of the shares receives 60 percent of the total declared.
Two points trip people up. First, dividends come out of post tax profit, so the company has already paid 19 to 25 percent corporation tax on that money before a penny reaches you. Second, a dividend paid when the company had no available profit is unlawful and can be reclaimed, which is a real risk for owner managed companies that pay themselves through the year without watching the reserves. We see it most often when a good year is followed by a quiet one and the habit of monthly dividends carries on regardless.
Dividend Tax Rates for 2026/27
Dividends have their own tax rates, separate from the Income Tax rates on salary, and separate from National Insurance, which dividends do not attract at all. This is the main reason owner directors have historically favoured them.
For the 2026/27 tax year the rates are:
| Tax band | Dividend tax rate 2026/27 | Rate in 2025/26 |
|---|---|---|
| Basic rate | 10.75% | 8.75% |
| Higher rate | 35.75% | 33.75% |
| Additional rate | 39.35% | 39.35% |
The important change is at the top of that table. At the Autumn Budget on 26 November 2025 the Chancellor raised the basic and higher dividend rates by 2 percentage points from 6 April 2026. The additional rate was left alone. So basic rate taxpayers now pay 10.75 percent rather than 8.75 percent, and higher rate taxpayers pay 35.75 percent rather than 33.75 percent. If you took dividends last year and your circumstances have not changed, your bill on the same amount is higher this year.
The band your dividends fall into depends on your total income. Dividends are treated as the top slice, meaning they stack on top of your salary and other income when deciding which rate applies. The thresholds for 2026/27 are the familiar ones, frozen again: a Personal Allowance of £12,570, the basic rate band running to £50,270, the higher rate band from there to £125,140, and the additional rate above that.
The Dividend Allowance
On top of the Personal Allowance, everyone gets a separate tax free dividend allowance. For 2026/27 it is £500. The first £500 of dividend income each year is tax free no matter which band you sit in, and it does not use up your Personal Allowance.
It is worth remembering how far this allowance has fallen. It was £5,000 when introduced in 2016, dropped to £2,000, then £1,000, and now sits at £500. A shareholder taking modest dividends a decade ago paid nothing. The same person today is taxed on almost all of it. That steady erosion, combined with this April's rate rise, is why the gap between salary and dividends has narrowed and why the old reflex of paying yourself almost entirely in dividends deserves a fresh look each year.
A Worked Example
Numbers make this clearer than any amount of explanation. Take a director who pays herself a salary of £12,570, exactly covering the Personal Allowance, and then takes £20,000 in dividends.
- The salary of £12,570 is covered by the Personal Allowance, so there is no Income Tax on it.
- Of the £20,000 in dividends, the first £500 is covered by the dividend allowance and is tax free.
- Her total income is £32,570, comfortably inside the basic rate band, so the remaining £19,500 of dividends is taxed at the basic dividend rate of 10.75 percent.
- That gives a dividend tax bill of £2,096.25.
On exactly the same figures in 2025/26, when the basic rate was 8.75 percent, the bill would have been £1,706.25. So this director pays £390 more tax this year on an identical income, purely because of the rate change. For higher earners taking larger dividends, the effect of the 2 point rise is bigger again. Our dividend tax calculator lets you run your own numbers in a few seconds.
How and When You Pay the Tax
How you settle dividend tax depends on the amount. If your total dividends for the year are no more than £500, there is nothing to report and nothing to pay. If they fall between £500 and £10,000, you can either ask HMRC to collect the tax by adjusting your tax code, or report it through a Self Assessment return. If your dividends exceed £10,000, you must register for Self Assessment and file a return.
For owner directors this almost always means Self Assessment, because dividends of any real size push you over the £10,000 line. The tax is then due by 31 January following the end of the tax year, the same deadline as the rest of your Self Assessment bill. Setting that money aside as you go, rather than finding it in January, is one of the simplest cash flow habits we recommend to company directors.
Dividends Versus Salary
Because this guide keeps circling back to it, here is the heart of the matter for anyone running their own company. A salary is a company expense, so it reduces the profit on which corporation tax is charged, but it carries Income Tax and both employee and employer National Insurance. A dividend carries no National Insurance and is taxed at lower headline rates, but it comes out of profit the company has already paid corporation tax on, so there is no further relief for the business.
The most tax efficient answer is rarely all of one or all of the other. For most owner managers it is a small salary, often set around the National Insurance thresholds to preserve a state pension record, topped up with dividends. The exact split shifts every time the rates move, and with dividend rates rising this April the maths has tilted. We cover the wider picture in our guide to directors' remuneration, and the structural choice that sits underneath it all in sole trader versus limited company.
Our View
Dividends are not a tax loophole, and treating them as free money is how owner directors get into trouble. The two mistakes we see most often are paying dividends the company is not legally allowed to pay, and leaving the salary and dividend split on autopilot year after year while the rules quietly change underneath it.
On the first point, discipline is everything. Before you take a dividend, you should be able to point to the profit it comes from. Keep your bookkeeping current, look at the distributable reserves, and minute the decision. It takes minutes and it is the difference between a clean dividend and one HMRC or an insolvency practitioner can unwind later.
On the second, this is the year to actually review the split rather than repeat last year's. The basic and higher dividend rates have just gone up by 2 points, the allowance is stuck at £500, and the thresholds are frozen, which quietly drags more people into higher rate as their income grows. None of that is catastrophic, but it does mean the comfortable assumptions of a few years ago no longer hold. A short conversation each tax year, before the year end rather than after, is usually all it takes to stay on the right number.
How IAK Can Help
We work with limited company directors across North London who pay themselves through a mix of salary and dividends, and we make sure both halves are right. Our personal tax team models your salary and dividend split each year against your forecast profit and the current rates, so you take what is most efficient without crossing any lines. Our accounting and bookkeeping work keeps your reserves visible, so every dividend you declare is one the company can lawfully pay.
If you are not sure how much you can take, how it will be taxed, or whether your current split still makes sense after this April's changes, contact us for a free consultation. We will give you a straight answer and a number you can rely on.
Sources
- Tax on dividends, GOV.UK, on the £500 dividend allowance, how dividends stack on top of other income, and how to report dividend income depending on the amount.
- Changes to tax rates for property, savings and dividend income, GOV.UK, on the 2 percentage point increase to dividend tax rates from 6 April 2026, announced on 26 November 2025.
- Companies Act 2006, Part 23 Distributions, legislation.gov.uk, on the requirement that dividends be paid only out of distributable profits.