If you’re a contractor, freelancer, or small business owner operating through a limited company, you’ve probably heard a lot about dividends. But what exactly are dividends, how do they work, and who is entitled to them?

This guide explains everything you need to know about dividends: from what a dividend is, to how they’re calculated, and how contractors can use dividends to manage their income tax efficiently.

At Nexus Accounting, we specialise in supporting contractors and limited company directors with dividend planning, compliance, and tax efficiency. Learn more about our services, including dividend tax for contractors, paying dividends to shareholders, and paying company dividends.

• What Is a Dividend?
• Who Can Receive Dividends?
• How Are Dividends Calculated?
• Declaring and Paying a Dividend
• Dividend Tax for Contractors
• Dividends vs Salary
• When Can’t You Pay Dividends?
• Paying Dividends to Shareholders
• Key Takeaways for Dividends
• Practical Tips for Managing Dividends
• Frequently Asked Questions

What Is a Dividend?

A dividend is a share of company profit that is distributed to shareholders after tax has been paid. After covering business expenses, VAT (if registered), and corporation tax, the remaining profit can be distributed to shareholders in the form of dividends.

Key Facts About Dividends:

• Only payable from post-tax profits
• Only payable to shareholders
• Normally distributed in proportion to shareholding

Who Can Receive Dividends?

Dividends are available to shareholders only. That means:

• Contractors and freelancers who own 100% of their limited company shares
• Family members or spouses who hold shares
• Investors or partners who have been issued shares

This flexibility is useful for tax planning. For example, if your spouse pays tax at a lower rate, sharing dividends between you may reduce your household tax liability.

How Are Dividends Calculated?

The dividend calculation process is simple in principle:

1. Start with company profits after expenses.
2. Deduct company liabilities including corporation tax.
3. The remainder is retained profit, available for dividends.

Example calculation:

• Turnover: £100,000
• Business expenses: £20,000
• Profit before tax: £80,000
• Corporation tax (19%): £15,200
• Profit after tax: £64,800
• Available dividends: £64,800

You don’t have to distribute the entire amount, you can keep some profits within the business.

Declaring and Paying a Dividend

Dividends must be formally declared, even in a one-person company.

Steps include:

• Board meeting minutes (even for sole directors)
• Dividend vouchers with company details, shareholder name, date, and amount
• Payment into shareholders’ personal accounts

Failing to follow this process may result in HMRC reclassifying payments as salary, which could trigger extra tax and National Insurance.

Dividend Tax for Contractors

Dividends are taxed differently to salary and are a key reason many contractors choose to operate through limited companies.

UK Dividend Tax Rates 2025/26:

• £500 dividend allowance (tax-free)
• 8.75% for basic rate taxpayers
• 33.75% for higher rate taxpayers
• 39.35% for additional rate taxpayers

Dividends do not attract National Insurance contributions, making them highly tax efficient when combined with a modest director’s salary. Dividend income must be reported on your Self Assessment tax return.

IR35 Considerations

Whether you fall inside or outside IR35 will influence the way dividends should be best allocated:

• Outside IR35: Dividends remain a tax-efficient way to pay yourself.
• Inside IR35: Dividends lose their advantage, as your income is treated as employment income under PAYE.

Understanding IR35 is essential to dividend planning for contractors.

Dividends vs Salary: What’s the Difference?

When you run a limited company, you can pay yourself through a salary, dividends, or a combination of both. Each method has different tax implications, and choosing the right mix can significantly improve your take-home pay.

Salary:

• Paid before Corporation Tax is calculated
• Subject to PAYE (Pay As You Earn) and National Insurance Contributions (NICs)
• Treated as a deductible business expense, which reduces your company’s taxable profit
• Counts towards your state pension and benefits eligibility

Dividends:

• Paid after Corporation Tax has been applied to company profits
• Not subject to NICs
• Taxed at lower dividend tax rates (8.75%, 33.75%, or 39.35% depending on your income band)
• Can only be paid if the company has sufficient retained profits

What’s the Most Tax-Efficient Setup?

For many contractors and small business owners, the most tax-efficient approach is a low salary + high dividend structure. This setup allows you to:

• Stay within the NIC-free threshold
• Keep your income tax liability low
• Maximise your pension and state benefit contributions

TIP: Paying a salary just above the NIC threshold ensures you qualify for the state pension without paying National Insurance.

Want to make sure you’re paying yourself in the most efficient way? Speak to an expert accountant at Nexus today for tailored advice based on your income, business goals, and tax bracket.

When Can’t You Pay Dividends?

Dividends are only legal if:

• The company has sufficient post-tax profit
• Proper paperwork is produced

Paying dividends without available profits creates illegal dividends, which HMRC may reclassify as salary. This leads to unexpected tax bills and penalties.

Paying Dividends to Shareholders

Dividends are usually split pro rata by shareholding:

• If you own 80% of shares, you receive 80% of dividends declared
• If your spouse owns 20%, they receive 20%

With different share classes, you can distribute unevenly,  but this must be structured correctly for tax compliance.

Key Takeaways for Dividends

• Dividends can only be paid from profits after tax
• Only shareholders are entitled to dividends
• They are taxed separately at special rates, usually lower than salary tax + NICs
• Proper documentation is essential (vouchers, minutes)
• Dividends are most effective as part of a salary + dividends mix

Practical Tips for Managing Dividends

• Keep accounts accurate and up to date
• Always plan for corporation tax and personal dividend tax
• Document dividend payments properly
• Consider share transfers to spouses for tax efficiency
• Seek advice before creating multiple share classes

Frequently Asked Questions

What is the benefit of paying dividends as a contractor?

Dividends reduce National Insurance contributions and are usually taxed at a lower rate than salary, improving your take-home pay.

Can I pay myself dividends monthly?

Yes, but each payment must be properly declared and supported with paperwork. Many contractors pay themselves monthly or quarterly dividends.

What happens if I take dividends without profit?

This creates illegal dividends. HMRC may reclassify them as salary and charge tax/NICs plus penalties.

Learn More About Limited Company Dividends with Nexus Accounting Experts

Dividends are one of the most efficient ways for contractors and limited company directors to reward themselves from business profits. However, they must always be declared legally, backed by profits, and correctly reported to HMRC.

At Nexus Accounting, we help contractors, freelancers, and small businesses navigate dividend tax, shareholder payments, and compliance with ease.

Get in touch with us today to discuss dividend tax for contractors, paying dividends to shareholders, or company dividend services.

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