Limited companies make dividend payments to their shareholders from any profits left over after tax. The dividends that you pay out to shareholders don’t have to be for an equal amount, but your shareholders will need to have different classes of shares for this to happen. In this article we explain how dividends can be paid out for unequal amounts.
Shares are used to show ownership of a limited company – literally a share of the business. Some shareholders might own more shares than others, which means that they own different percentages of the business.
The percentage of shares owned is used to calculate the amount of dividends that a shareholder receives. Someone who owns 30% of a business’ shares will usually receive 30% of the profits, for example. Working on this basis can help to ensure that shareholders get a proportional amount according to their investment in the business.
This assumes that all of the shareholders own the same type of shares, but there might be times that a company wants to pay them in a different way. Creating different classes of shares, sometimes called alphabet shares, allows a company to do this.
The term ‘alphabet shares‘ describes the different classes of shares that can be issued by a limited company. They tend to be labelled in the company’s accounts as A shares, B shares, C shares and so on, hence the name alphabet shares!
Creating different classes means that each type can be assigned different rights. These could be voting rights, or the percentage of dividends that the shareholder of that particular class of share is entitled to.
For instance, an ‘A share’ shareholder might be paid dividends at a different rate to a ‘B’ shareholder. A ‘C’ shareholder may not have the same voting rights as a ‘B’ shareholder. This means that you could have a variety of shareholders with very different dividend payouts and voting rights.
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What are the benefits of paying different dividends out?
If you’re just dividing by share ownership, the benefit is that it’s a fair and simple way of dividing company profits. But what about alphabet shares?
Using different classes of shares means that a limited company can be more flexible in the way it pays out dividends.
It lets the company move beyond a pro rata basis of ownership, and instead pay shareholders based on their involvement or investment in the company.
- You might want to appoint family members as shareholders but not give them voting rights. For instance, if you have children that you would like to receive dividends, but they don’t need to make decisions about the business.
- Or, you might invest in a startup and own the majority of it without being involved in day-to-day operations. In that case, it might be agreed that the other directors will receive a larger share of the profits, whilst you still own most of the company.
Creating alphabet shares can become really useful in this sort of situation, giving you more control over who can influence the business.
What does this mean for tax?
Shareholders who receive dividend payments may need to pay Dividend Tax on this type of income. The amount of income they receive in a tax year, and the amount of dividends they earn, affects how much Dividend Tax they need to pay.
You’ll need to tell Companies House about the shares in your business when you first incorporate the company, or if you allot more shares later on. They’ll also need to know the details of each shareholder and what it is that they hold.
The details of what your shareholders (and different types of shares) are entitled to should be recorded in the company’s Articles of Association. This document is a bit like having written rules which set out how to run the company.
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FAQs
There's no limit, and no set amount – you might even pay your shareholders different dividend amounts. Dividends are paid from a company's profits, so payments might fluctuate depending on how much profit is available.
Can you pay different dividends to different shareholders? ›
In order to pay your shareholders unequal dividends, your shareholders will need to hold different classes of shares. The directors will then declare: a certain dividend on one class of share; and. a different dividend (or no dividend at all) on the other class or classes.
Can you pay dividends in a partnership? ›
Sole traders, partnerships and LLPs can't pay dividends, because they do not issue shares. Limited companies are only allowed to pay dividends if they have enough profit available to do so - and the dividend payment comes out of profit after Corporation Tax.
Is there a limit on dividend payments? ›
There is no limit as to how often or how much a company can pay in dividends and some directors choose to take a dividend monthly to become more tax efficient.
How does the paying dividends affect the business accounting equation? ›
When the dividends are paid, the effect on the balance sheet is a decrease in the company's retained earnings and its cash balance. In other words, retained earnings and cash are reduced by the total value of the dividend.
Can shareholders have unequal distributions? ›
Under federal law, a “disproportionate distribution” is a corporation's distribution of property with respect to certain shares of its stock that differs in timing or amount from distributions with respect to any other shares of its stock.
Are dividends to common and preferred shareholders paid at the same time? ›
Preferred shareholders have priority over a company's income, meaning they are paid dividends before common shareholders.
Do partnerships have to share profits equally? ›
In particular, in a partnership business, all partners share liabilities and profits equally, while in others, partners may have limited liability. There also is the so-called "silent partner," in which one party is not involved in the day-to-day operations of the business.
Are distributions of profits taxable to owners in a partnership? ›
Are partnership distributions taxable? Because each individual partner pays taxes on their share of the partnership income, they are not taxed on any withdrawals or distributions.
How to pay dividends to shareholders? ›
Most companies prefer to pay a dividend to their shareholders in the form of cash. Usually, such an income is electronically wired or extended in the form of a cheque. Some companies may reward their shareholders in the form of physical assets, investment securities and real estates.
Rule 3 of Dividend Rules prescribes the conditions to be complied with for declaring dividend out of reserves. A pertinent question here is – whether a company can declare dividend out of 100% of the amount that has been transferred to General Reserve.
How do you treat dividends in accounting? ›
Under generally accepted accounting principles (GAAP), dividends are not considered an expense of doing business; instead, they are accounted for as a reduction of equity on the balance sheet and added back to net income to compute earnings per share.
What happens if you pay too much dividends? ›
If a company pays out more dividends than it can afford, the excess amount must be returned to the company or be added to the director's loan account as a debt from the shareholder to the company. Having an overdrawn directors loan account can result in both income tax and corporation tax consequences.
Do dividends have to be paid equally? ›
A company will be unable to pay different rates of dividend to its shareholders unless it is clearly provided for. Failure to do so can result in the dividend being unlawful, resulting in the company's directors being in breach of their legal duties.
Can you pay more dividends than retained earnings? ›
Still, in the vast majority of cases, companies can't pay dividends that exceed their retained earnings. Dividend investors should therefore keep an eye on the balance sheets of the companies whose stock they own to get an early warning of any potential problem with paying dividends in the future.
What accounting activity is paying dividends? ›
Dividends paid are classified as financing activities.
Can you pay a dividend to one shareholder and not the other? ›
Creating different share classes means each type can be assigned different rights. These could be voting rights, or the percentage of dividends the shareholder of that particular class of share is entitled to. For instance, an 'A share' shareholder might be paid dividends at a different rate to a 'B' shareholder.
Do ordinary shareholders always share equally with all other shareholders in all dividends? ›
Common shareholders are paid the residual dividend left after paying the preferred dividend. Hence, it is incorrect to say that common shareholders are paid equally with all other shareholders. The statement is false.
Can stockholders pay different prices for the same stock? ›
Depending upon the current market price, stockholders may pay different prices for the same stock.
What is differential dividend? ›
the directors of a public company may pay a Differential Dividend if different dividend rights are provided for in the constitution of, or by a special resolution passed by shareholders of, the company.
