Are Dividends Tax Deductible

Introduction

At Towerstone, we provide accountancy services in Bedford to local sole traders, landlords, and limited companies. We have written an article about Are Dividends Tax Deductible to help you understand why dividends are treated differently, and how tax is applied in practice.

This is a question I hear all the time from company directors especially those who are new to running a limited company. From experience it usually comes up when someone starts comparing salary versus dividends and wants to understand which route is more tax efficient overall. Dividends feel like a cost of running a company because they are paid out of company money so it is natural to ask whether they reduce the company’s tax bill.

The short answer is no dividends are not tax deductible. However the reasons why and the wider tax picture matter far more than the headline answer. Many people misunderstand how dividends fit into the tax system and that misunderstanding can lead to poor planning or unexpected tax bills.

In this article I want to explain clearly whether dividends are tax deductible in the UK how HMRC treats them in practice and why they are still widely used by directors despite not reducing corporation tax. I will also cover how dividends differ from salary who can receive them and the common mistakes I see. This is written from real UK accountancy experience and reflects how the rules actually work rather than how people assume they work.

What Dividends Actually Are

A dividend is a distribution of profits to shareholders.

That definition is critical.

Dividends are not a business expense. They are a way of sharing profits after the company has already made money and after corporation tax has been considered.

This is why dividends are fundamentally different from costs such as wages rent or utilities.

From HMRC’s perspective dividends are an allocation of profit not a cost incurred in earning that profit.

The Simple Answer on Tax Deductibility

I will say this clearly to avoid any ambiguity.

Dividends are not tax deductible.

A limited company cannot deduct dividends when calculating its corporation tax bill.

This applies regardless of:

The size of the dividend
Who receives it
Whether it is paid monthly or annually
Whether the director relies on it as income

Corporation tax is calculated first. Dividends are paid second.

Why Dividends Are Not Tax Deductible

HMRC’s logic here is straightforward.

Tax relief is given for expenses incurred wholly and exclusively for the purposes of the trade. Dividends do not meet that test because they are not incurred to generate income. They are paid because income has already been generated.

Allowing companies to deduct dividends would effectively allow profits to escape corporation tax altogether.

From experience this is where people often say it feels like double taxation. In a sense that is true but it is also how the system is designed.

How Dividends Are Taxed in Practice

Dividends sit within a two layer tax system.

First the company pays corporation tax on its profits.

Then shareholders pay personal tax on the dividends they receive.

This is different from salary which is taxed only once but attracts National Insurance.

From experience the key to understanding dividends is to look at the combined tax position not just one layer in isolation.

Dividends vs Salary for Directors

This is where dividends still play an important role despite not being tax deductible.

Salary is a deductible expense for the company. It reduces corporation tax. However salary attracts income tax employee National Insurance and employer National Insurance.

Dividends are not deductible. However they do not attract National Insurance.

From experience dividends are often more tax efficient overall for owner directors especially when combined with a modest salary.

Why Directors Still Use Dividends

Even though dividends do not reduce corporation tax many directors still choose them because:

They are not subject to National Insurance
They allow flexible income planning
They can be timed around tax thresholds
They are simpler to administer than payroll increases

The tax saved on National Insurance often outweighs the lack of corporation tax relief.

Who Can Receive Dividends

Only shareholders can receive dividends.

This sounds obvious but from experience it causes confusion particularly in family companies.

You cannot pay dividends to:

Employees who are not shareholders
Contractors
Directors who do not own shares

Dividends must be paid in proportion to share ownership unless different classes of shares exist.

Dividends Must Come From Profits

This is a critical rule that is often misunderstood.

Dividends can only be paid from distributable profits.

That means:

The company must have made profits
Previous losses must be covered
Accounts must support the dividend

You cannot legally pay dividends just because there is cash in the bank.

From experience illegal dividends are one of the most common issues uncovered during HMRC enquiries and company accounts reviews.

Dividends and Retained Profits

Dividends reduce retained profits on the balance sheet.

They do not appear as an expense in the profit and loss account.

This accounting treatment reflects their nature as a distribution rather than a cost.

Understanding this distinction helps explain why they are not tax deductible.

Dividends for Sole Traders and Partnerships

This point is simple.

Sole traders and partnerships cannot pay dividends.

Dividends only exist in limited companies because they relate to shares and shareholders.

From experience people sometimes use the word dividend loosely when they actually mean drawings. These are very different things with very different tax treatment.

Dividends and Director’s Loan Accounts

Sometimes directors take money out of the company before dividends are formally declared.

This creates a director’s loan account balance.

Dividends can later be declared to clear that balance provided profits exist and the dividend is properly documented.

From experience problems arise when dividends are backdated or assumed rather than declared correctly.

Personal Tax on Dividends

Dividends are taxed differently from salary.

There is a dividend allowance which taxes the first portion at zero percent but it still counts towards income.

Above that dividends are taxed at dividend tax rates which are lower than income tax rates but still significant.

From experience directors often focus on the lower rates and forget that dividends stack on top of other income.

Dividends Paid to Spouses or Family Members

Dividends can be paid to spouses or family members if they are genuine shareholders.

This can be part of legitimate tax planning but it must be structured correctly.

HMRC will challenge arrangements where shares have no real ownership or rights.

From experience family share structures need careful setup to be robust.

Dividends and Timing

One advantage of dividends is timing flexibility.

Dividends are taxed in the tax year they are paid not when profits are earned.

This allows directors to plan income across tax years.

However timing does not change the fact that dividends are not deductible for corporation tax.

Common Myths I Hear All the Time

From experience these misconceptions come up repeatedly.

Dividends reduce corporation tax
They do not.

Dividends are just another type of expense
They are not.

If I call it a dividend HMRC cannot tax it as salary
Incorrect if the conditions are not met.

Dividends can be paid whenever there is cash
Only if profits exist.

What Happens If Dividends Are Paid Incorrectly

If dividends are paid without sufficient profits they may be treated as:

Director’s loan account withdrawals
Repayable amounts
Potential income in extreme cases

This can create tax and legal issues.

From experience correcting illegal dividends after the fact is stressful and avoidable.

How Dividends Should Be Documented

Proper documentation matters.

Dividends should be supported by:

Board minutes
Dividend vouchers
Evidence of profits

This protects both the company and the director.

From experience HMRC places significant weight on paperwork when reviewing dividends.

How Accountants Add Value With Dividends

This is where professional advice is essential.

Accountants help by:

Confirming profits available
Advising on salary and dividend mix
Ensuring dividends are legal
Timing dividends tax efficiently
Avoiding director’s loan problems

From experience most dividend issues arise not from bad intent but from lack of understanding.

Dividends for Bedford Company Directors in Practice

Working with Bedford based company directors I see dividends used successfully across many sectors.

Professional services
Property companies
Trades operating through limited companies
Consultancies and digital businesses

The common thread in successful cases is planning rather than guesswork.

Should You Avoid Dividends Because They Are Not Deductible

No and this is an important point.

The fact that dividends are not tax deductible does not mean they are a bad choice.

Tax efficiency is about the combined position across corporation tax income tax and National Insurance.

From experience dividends remain a valuable tool when used correctly.

The key takeaway

I have to say this clearly.

Dividends are not tax deductible and they never have been. That is not a loophole and it is not something that can be changed with clever wording.

However dividends are still widely used because they often result in a lower overall tax burden compared to salary alone.

In my opinion the mistake is not using dividends. The mistake is using them without understanding how they work.

If there is one takeaway from this article it is this.

Always look at dividends as a distribution of profit not a business cost.

When you understand that distinction dividends stop being confusing and start becoming a strategic part of how company directors pay themselves in a compliant and tax efficient way.

For further guidance across related topics, visit our Bedford Accounting Hub, which brings together practical advice for Bedford clients.