Directors' dividends are distributions of a company's profits paid to directors who also hold shares in the company, in proportion to their shareholding. Essentially, they represent a share of the business's profits allocated to its owners, including those who are also directors.
Understanding the Basics of Dividends
A dividend is fundamentally a portion of a company's financial success shared with its shareholders. For a company to pay dividends, it must first have generated profits. These profits are calculated after the company has settled all its financial obligations, including taxes owed to the government. If there are no accumulated profits available, then no dividends can legally be paid.
Key characteristics of dividends:
- Profit-dependent: Dividends can only be paid from a company's distributable profits.
- Shareholding basis: They are distributed to shareholders based on the number of shares they own. A director receives dividends because they are a shareholder, not solely because of their directorship.
- Decision by the board: The decision to declare and pay dividends is typically made by the company's board of directors.
How Directors Receive Dividends
Directors, like any other shareholder, receive dividends according to the proportion of shares they hold in the company. For example, if a director owns 60% of a company's shares, they would be entitled to 60% of any declared dividend distribution. This mechanism ensures fairness and aligns the director's personal financial interest with the company's profitability.
It's important to differentiate dividends from a director's salary. While a salary is a regular payment for services rendered and is an operating expense for the company, dividends are a distribution of profits after all expenses and taxes have been accounted for.
Dividends vs. Salary for Directors
Directors often have the option to take remuneration as either a salary, dividends, or a combination of both. Each option has different implications for the company and the director, particularly concerning taxation.
Here’s a simplified comparison:
| Feature | Dividends (for Directors/Shareholders) | Salary (for Directors) |
|---|---|---|
| Source | Company's after-tax profits (distributable reserves) | Company's pre-tax expenses |
| Eligibility | Shareholder (payment is proportional to shares held) | Employee/Office holder (payment for services rendered) |
| Company Tax | Corporation tax paid by the company on its profits before dividends | Deductible business expense, reducing the company's taxable profit |
| Personal Tax | Subject to personal income tax on dividends, typically at specific rates | Subject to PAYE income tax and National Insurance contributions (NICs) |
| National Ins. | No National Insurance contributions payable | Employee and Employer National Insurance contributions payable |
| Payment Basis | Declared by the board, based on available profits | Agreed remuneration, typically paid regularly (e.g., monthly) |
| Legality | Must be paid from accumulated profits; requires board resolution | Contractual agreement for services rendered |
For many owner-directors of small companies, a common strategy involves taking a small salary (to protect National Insurance records and potentially reduce corporation tax) and topping up their income with dividends. This approach can be more tax-efficient overall compared to a larger salary, depending on individual circumstances and current tax laws. However, it's crucial to consult with a qualified accountant for personalized advice on the most tax-efficient structure.
Practical Considerations for Directors' Dividends
- Legal Process: Dividends are not paid automatically. The company's directors must formally declare them through a board resolution, ensuring that sufficient distributable profits exist. This process is typically documented in meeting minutes.
- Communication: Companies must issue dividend vouchers to shareholders, including directors, detailing the gross dividend, any tax credits, and the net payment.
- Impact on Company Finances: While attractive for directors, excessive dividend payments can deplete a company's cash reserves, potentially hindering future investments or growth. A balanced approach is crucial for long-term sustainability.
- Compliance: Companies must comply with the Companies Act 2006 regarding dividend payments, ensuring they are only paid from distributable profits. Failure to do so can lead to serious legal consequences for directors. For detailed information on company regulations, you can refer to resources like GOV.UK's guidance on company accounts and tax.
In summary, directors' dividends are a legitimate way for directors who are also shareholders to receive a share of their company's success. They are intrinsically linked to the company's profitability and must adhere to specific legal and financial protocols.
