Dividends – do all shareholders get them?

Companies limited by shares usually distribute profit to their members (shareholders) in the form of cash dividend payments. Dividends are issued to all members whose shares provide dividend rights, which most do.

In this post, we discuss the rules and procedures for issuing dividends in a limited company, including how payments are worked out, the different types of dividends available, the duties of directors during the process, and the consequences of paying illegal dividends.

Issuing dividends in a limited company

Company profits are distributed proportionally, based on the percentage of shares that each member holds. These distributions are often described in terms of the following:

• Dividend rate—the actual amount that is paid out in respect of each share (e.g. £1)
• Dividend yield—the dividend rate paid out per share, expressed as a percentage of the current stock value (e.g. if the dividend rate is £1 but the market value of each share is £50, then the dividend yield is 2%)

Dividend payments don’t always comprise an organisation’s entire profit. Many companies reinvest at least some of their profit back into the business. This accumulated portion of profits after dividend distributions is known as ‘retained earnings’.

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Companies cannot count dividends as business expenses when calculating Corporation Tax. This is because dividends are paid from post-tax profits—the surplus income left after the company has accounted for all running costs, including Corporation Tax liability.  

Furthermore, companies must pay no more in dividends than is available from profits already accumulated and eligible for this purpose. These available profits are known as ‘distributable reserves’ or ‘distributable profits’.

If a company distributes more in dividends than it has available for such purposes, the payments will be deemed unlawful or illegal dividends. 

What is the procedure for paying dividends?

Broadly speaking, there are two types of dividends: final and interim. Below, we consider the general rules that apply to the payment of dividends. We also distinguish between interim and final dividends.

General rules

By law, company directors must hold a board meeting before issuing dividends. The purpose of the meeting is for the directors to ‘declare’ a dividend (either themselves or subject to approval by the members). Meeting minutes must be kept, even in companies with only one director. 

Directors must create a dividend ‘voucher’ for each dividend payment. These vouchers should contain the following information:

• date of dividend payment
• amount of the dividend
• name of company
• names of shareholders eligible to receive a portion of the dividend payment

Every shareholder eligible to receive a portion of the dividend should receive a copy of the voucher. The company should also retain copies for its records.

The rules for issuing and paying dividends can vary from company to company. Any specific company procedures, conditions, or restrictions should be stated in the articles of association and, if applicable, a shareholders’ agreement. 

A free dividend voucher template is available from 1st Formations.

Final dividends

Companies issue final dividends based on profits for the financial year. As such, most companies declare and pay them only once a year following the approval of their annual accounts.

Directors will recommend the dividend amount. However, they must seek approval from members at a general meeting or via written resolution. At this point, the shareholders can either approve or reduce the level of dividend payment. They cannot declare a higher amount.

Upon declaring and approving the final dividends, the company must pay the agreed amount to eligible shareholders.

Interim dividends

Interim dividends can be paid out at any time during a company’s financial year rather than at the end. 

Subject to any restrictions in the articles or shareholders’ agreement, directors can declare this form of dividend without seeking approval from members.

Any decision to pay an interim dividend must be on the basis of relevant interim accounts, which the company should file with Companies House.

If the directors alone declare an interim dividend, the company does not have to make the payments. The board can revoke its decision if the company’s circumstances change.

What are the duties of directors when declaring dividends?

In accordance with the Companies Act 2006 (‘the Act’), a company director ‘must exercise reasonable care, skill and diligence’ and ‘act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole’.

Directors must consider these specific duties—along with their other responsibilities to the company and its members—when deciding whether to recommend a dividend payment. 

As such, they should first ensure they fully understand the rules surrounding dividend payments. They must also carefully assess the company’s financial position to determine whether the level of dividend payments is appropriate.

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To understand whether a company has sufficient distributable profits, the directors should refer to the latest annual accounts circulated to members. The balance sheet in those accounts will usually show the company’s ‘retained earnings’ or ‘profit and loss reserves’—or, if it’s a micro entity, its ‘capital and reserves’. 

The directors must determine the portion of those reserves qualifying as funds available to distribute as dividends. Doing so will help avoid the potential for unlawful dividends. 

Aside from ensuring that dividend payments fall within the limits of available distributable reserves, it’s essential to consider the company’s overall position to meet its debts. Depending on when the latest accounts were prepared, the company’s financial health may have changed. 

Consequences of issuing illegal dividends 

Section 830 of the Act states that: ‘A company may only make a distribution out of profits available for the purpose’ that consists of ‘its accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital duly made.’

Companies must also comply with the Act’s dividend procedure and documentation requirements when declaring and paying dividends.

Issuing dividends in contravention of these statutory rules can result in unlawful (illegal) dividends, the consequences of which can be severe. 

• Directors who authorise dividend payments when the company has insufficient distributable profits are personally liable for any consequent shortfalls.
• Directors may also be liable if they pay dividends when the company is insolvent or if they should have reasonably foreseen cash flow problems.
• Shareholders who know (or have reasonable grounds to know) that a dividend is unlawful will be liable to repay the dividend to the extent of the unlawful amount.
• An unlawful dividend will always remain as such—it can never become lawful.
• The company may have difficulty obtaining credit by virtue of an unlawful dividend in its accounts creating the appearance of balance sheet insolvency.

Technical guidance on realised and distributable profits under the Companies Act is available from the Institute of Chartered Accountants in England and Wales (ICAEW).

How do companies pay dividends to shareholders?

Traditionally, companies paid dividends via cheque, but making payments by direct bank transfer is now more common. However, shareholders usually have a choice. Companies will generally stipulate the available payment methods in their articles of association or a shareholders’ agreement.

Sometimes, companies pay dividends in the form of additional shares, known as scrip dividends. Members often have the option to receive a dividend in cash or as additional shares.

One benefit of opting for a scrip dividend is the ability to avoid transaction costs on purchasing new shares. However, there is no tax advantage because HMRC treats scrip dividends the same way as cash dividends for taxation purposes.

Dividend payments have an annual tax-free allowance of £500 (applicable to the 2024-25 and 2025-26 tax years). After this, they are subject to dividend tax according to the shareholder’s Income Tax band:

• 8.75% at the basic rate
• 33.75% at the higher rate
• 39.35% at the additional rate

It is worth mentioning that some companies also offer dividend reinvestment plans (DRIPs) that provide members with more shares instead of cash. However, there are some important technical differences between drip and scrip dividends.

Multiple classes of shares and dividends

Some companies offer different classes of shares for the purpose of organising a specific distribution of dividend payments. For example:

Ordinary shares

Companies can separate ordinary shares into alphabet classes, assigning letters to differentiate them. For example, “A” ordinary shares, “B” ordinary shares, “C” ordinary shares”, etc. The company can then apply a different dividend rate to each class of alphabet shares.

Preference shares

Preference shares have a fixed dividend rate and are payable before other share classes. This means that they take precedence over ordinary share dividends. After paying preference shareholders, companies will distribute any remaining amount between the holders of ordinary shares.

Cumulative preference shares

These are similar to preference shares. However, they provide that if a dividend payment is missed or not paid in full (e.g., due to insufficient distributable profits), the shareholder will receive any shortfall in a future dividend payment when sufficient distributable reserves exist.

Deferred ordinary shares

Holders of these types of shares will not receive any dividend payment until holders of the other shares have received a minimum dividend. They will receive the same dividend rate as other shareholders.

Non-dividend paying shares

This share class excludes its holders from receiving dividend payments. However, they will carry other shareholder rights, such as voting at meetings, the power to remove directors, and the right to capital upon winding up.

Requirements when creating multiple share classes

Any decision to create new classes of shares to distinguish dividend rights requires approval by ordinary resolution at a board meeting or general meeting. The correct course of action depends on whether directors can make such decisions with or without shareholder approval. 

The minutes of the meeting should reflect the approval and be filed accordingly.

If necessary, the members must also amend the articles of association accordingly (e.g. if they do not permit the creation of new share classes).

Dividend waivers

On occasion, a shareholder may choose not to accept a dividend payment. This decision is known as a dividend waiver.

Shareholders may decide to waive dividends for the company’s benefit, keeping money in the business to reinvest in operations or growth. Depending on their objectives, this may be preferable to receiving payments and losing some of the profit through the consequent taxation of dividends.

A Deed of Waiver should be used to give effect to a dividend waiver. In the case of final dividends, the waiver should be put in place before the dividend is declared. Regarding interim dividends, the waiver should be set up before payment.

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