A UK company cannot pay a dividend just because it has cash in the bank. The Companies Act 2006 limits payouts to profits that are legally available for distribution, and shareholders who receive dividends then face their own tax rules.
What counts as a distribution in company law?
The Companies Act 2006 defines a distribution broadly. According to the legislation, it covers “every description of distribution of a company’s assets to its members, whether in cash or otherwise”. A dividend paid in cash is the familiar case, but the definition also reaches payments in other assets.
The Act carves out several items. Fully or partly paid bonus share issues, certain reductions of share capital, share buybacks and redemptions made under the relevant chapters of the Act, and distributions to members when a company is wound up are not treated as distributions for this purpose. Buybacks follow their own set of rules, so they are a separate topic from the dividend limits described here.
What is the profits-available-for-distribution rule?
The central rule sits in section 830 of the Act: a company “may only make a distribution out of profits available for the purpose”. Those profits are defined as the company’s accumulated, realised profits, so far as not previously used by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital.
Three features of that wording matter:
- Accumulated. The test looks across the company’s history, not just the latest year. A strong year does not automatically free up a dividend if earlier losses remain unwritten-off.
- Realised. Unrealised gains, such as a paper revaluation of property, do not usually count towards the pot.
- Not previously used. Profits already paid out as dividends cannot be paid out again.
Special variants apply to investment companies and certain insurers, so this explainer concentrates on ordinary trading companies.
How does the rule work in numbers?
A simple worked example shows the mechanics. Suppose a private company has accumulated realised profits of £400,000, of which nothing has yet been distributed, and accumulated realised losses of £150,000 that have not been written off.
| Item | Amount |
|---|---|
| Accumulated realised profits | £400,000 |
| Less accumulated realised losses | £150,000 |
| Profits available for distribution | £250,000 |
If the directors proposed a £300,000 dividend, it would exceed the available figure by £50,000 (£300,000 minus £250,000). The excess is where the problem lies, however healthy the bank balance looks. The figures are illustrative only and do not describe any real business.
Why do public companies face an extra test?
Section 831 adds a second hurdle for public companies. According to the Act, a public company may distribute only if its net assets are not below the total of its called-up share capital and its undistributable reserves, and the distribution does not push net assets below that total.
Net assets here means total assets less total liabilities. Undistributable reserves include the share premium account, the capital redemption reserve, certain unrealised profits, and any reserve that the law or the company’s own articles bar from distribution. In practice this means a listed company must clear both the profits test and the net assets test before a dividend is lawful. The aim is to keep a cushion of capital in the business for creditors.
Which accounts decide whether a dividend is lawful?
Section 836 says that lawfulness is judged by the items “as stated in the relevant accounts”. Those items include profits, losses, assets, liabilities, provisions, share capital and reserves. The relevant accounts are normally the company’s last annual accounts, although interim or initial accounts may be used in specified circumstances.
There is a catch. If the further requirements in sections 837 to 839 are not met, the Act says the accounts may not be relied on for these purposes, and the distribution is treated as unlawful. That is why dividend decisions are usually tied to properly prepared accounts rather than to a director’s sense of how the year went. Readers who want to understand what those accounts show can start with how to read a company’s financial story.
What happens if a dividend is unlawful?
Section 847 deals with the consequences. Where a distribution breaches the rules and the member “knows or has reasonable grounds for believing” that it was unlawful, the member must repay it to the company. For a non-cash distribution, the member must pay an amount equal to the value of what was received at the time.
The section does not affect any other duty to repay an unlawful distribution, so directors can face separate exposure under other parts of company law. This article does not cover those wider duties, but the point stands: a dividend is a legal act with a paper trail, not a casual transfer.
Why can a profitable company still struggle to pay a dividend?
Profit and cash are different things, and dividend law adds a third concept in distributable reserves. A company can report a profit and still lack cash because it has spent on stock, equipment or debt repayments. Equally, it can hold cash yet have no distributable profit because past losses sit on the balance sheet. The gap between earnings and cash is explored in why cash flow matters when revenue is growing, and the distinction between sales and earnings is covered in why revenue and profit tell different stories.
Boards therefore weigh several things at once: whether the legal test is met, whether cash is available, and whether the business needs to retain money for investment or to weather a downturn.
How are dividends taxed once they reach shareholders?
Company law governs whether a dividend can be paid; tax law governs what shareholders keep. According to GOV.UK, for the 2026 to 2027 tax year, running from 6 April 2026 to 5 April 2027, shareholders get a dividend allowance of £500 each year. Dividends above the allowance are taxed at these rates:
| Tax band | Rate on dividends over the allowance |
|---|---|
| Basic rate | 10.75% |
| Higher rate | 35.75% |
| Additional rate | 39.35% |
Illustrative arithmetic: a basic-rate taxpayer receiving £10,000 of dividends, with the full allowance available and no other dividend income, would have £9,500 taxable (£10,000 minus £500). At 10.75%, that is £1,021.25. A higher-rate taxpayer with the same dividends would owe 35.75% of £9,500, or £3,396.25. Real bills depend on other income, which band the dividends fall into and individual circumstances. For how different investment income is treated more broadly, see how tax works on investments outside an ISA.
Income tax bands for the same year, according to GOV.UK, include a Personal Allowance of £12,570, a basic rate band running from £12,571 to £50,270, and a higher rate band from £50,271 to £125,140, above which the additional rate applies.
What the dividend rules mean for reading company announcements
A dividend announcement tells readers that a board believes the legal and financial tests are met, but it is not proof of strength on its own. Useful questions include whether the payout is covered by earnings, whether it relies on past reserves, and whether it leaves enough cash for investment. A held or cut dividend may reflect caution rather than distress, while a maintained one may signal confidence or simply a reluctance to disappoint shareholders.
The underlying principle is straightforward: UK company law ties payouts to realised profits and, for public companies, to a capital cushion, and tax then applies on the shareholder’s side. Understanding both halves makes dividend headlines easier to interpret.
This article is general information, not personalised financial advice. Rules, rates and allowances change, so check current official guidance before making decisions.
Sources: Legislation.gov.uk; GOV.UK
