Can I Take Dividends From Previous Years Profits?

Dividends are a key financial tool, providing a tax-efficient way to reward shareholders and remunerate directors. They are a form of income, separate from salaries, and can be a tax-efficient way to extract money from your business.

A common question among business owners and investors is whether they can distribute dividends from profits earned in previous financial years. This can be a strategic move to maximise returns or address personal financial needs. However, there are specific rules and considerations to keep in mind.

Let’s take a closer look at dividends and how they are paid. 

Taking Money Out of a Limited Company

The process of dividend payment can be complicated. It begins with the directors making a formal decision to declare a dividend. This decision is not tied to the financial year end, and can be made at any point during the year, as long as there are sufficient funds available.

The directors then decide on the allocation of the dividend to shareholders. This could be a fixed amount per share or based on the proportion of shares held by each shareholder. It’s important to note that certain types of shares, such as preference shares, may have priority in receiving dividends.

There are several ways to take money from a limited company: 

• Salary: One common method is to pay yourself a salary. This is subject to income tax and National Insurance contributions, but it can reduce corporation tax.
• Dividends: Another way is through dividends to shareholders. This is often a more tax-efficient method, as dividends are taxed at a lower rate than salary. However, it’s important to follow tax office guidance to avoid any potential issues.
• Director’s Loan: Lastly, you can take out a director’s loan. This can be a complex area, so it’s always recommended to seek professional advice before proceeding.

Dividends are the most common way to take out money from a limited company, and the most tax efficient one, but there are still tax implications to watch out for. 

Shareholders must declare the amount of dividends received from a limited company to HMRC and pay Income Tax at the appropriate rate. The tax office guidance states that shareholders can receive dividends worth £2,000 tax-free in a year. Beyond this threshold, tax is levied on dividends at a rate based on the shareholder’s Income Tax band.

It’s always advisable to seek professional advice when dealing with dividends and taxes. This will ensure you’re following the correct procedures and help you reduce corporation tax, making the most of your limited company.

Dividends and Tax Consequences

When you draw a dividend from your company, the tax liability depends on the profit or loss of the company in the previous year.

Dividends are not free money. They are a distribution of profits and, as such, are subject to tax. Understanding this is a crucial part of any limited company guide.

You can minimise the taxes that you pay, however. One effective strategy is to balance your salary and dividends. This approach can help you take advantage of the lower tax rates on dividends while also reducing your corporation tax liability.

Another strategy is to utilise your dividend allowance, which is set at £2,000 for the 2021/22 tax year. This allowance is tax-free and is in addition to your personal allowance. By carefully planning your dividend extraction, you can maximise the use of this allowance and minimise your tax liability.

Can I Take Dividends from Previous Years Profits?

Dividends from previous years’ profits, often referred to as ‘retained earnings’, are a viable option for company directors. This is a common practice in the UK, where profits from a previous accounting year can be distributed as dividends in the following years.

This doesn’t mean you can avoid the tax office. The tax consequence of dividends is based on the tax year they’re paid, not the year the profit was made.

The process is straightforward. If your company has retained profits from the previous accounting year, these can be distributed as dividends. This is possible even if the company has made a loss in the current year, as long as the loss doesn’t exceed the previous year’s profit.

It’s crucial to ensure that these funds are not tied up in company assets or investments and are available as liquid cash. Remember to inform the tax office about your dividends to avoid any tax consequences.

In a limited company, dividends are usually distributed proportionally according to the number of shares each shareholder owns. For instance, if you own 20% of the shares, you’ll receive 20% of the total dividends declared.

It’s important to note that dividends can only be distributed from the company’s available profits. This means that the company must have made a profit and have enough funds left after covering all expenses and liabilities.

The first £2,000 of dividends in a year is tax-free. Beyond this threshold, the tax rate depends on the shareholder’s Income Tax band.

The company itself is not taxed on dividend payments. However, shareholders may have to pay Income Tax if their dividends exceed £500. Understanding these tax implications can help shareholders make informed decisions about their dividends and avoid any unwelcome surprises at tax time.

Final Thoughts on Understanding Dividends in UK Limited Companies

Understanding dividends in UK limited companies is crucial for both company directors and shareholders. Complying with the tax office guidance on dividends is crucial for any limited company in the UK. The first step is understanding that dividends can only be paid out of retained profits. This means that if your company makes a loss in a particular year, you can still pay dividends, provided there were retained profits at the start of the year and the loss hasn’t wiped out these profits.

Next, it’s important to remember that dividends are subject to income tax. The rate of tax depends on the shareholder’s income tax band. Basic rate taxpayers pay 8.5% tax on dividends, higher rate taxpayers pay 33.75%, and additional rate taxpayers pay 39.35%.

Always seek professional advice if you’re unsure about any aspect of dividend payments or tax consequences.