Limited companies can use their leftover profits after tax to make dividend payments to their shareholders. These dividend payments can be for different amounts depending on what type of shares the shareholder owns in the business. In this article we explain how dividend payments can be paid out for unequal amounts depending on what each shareholder is entitled to.
Limited companies are owned by their shareholders who, literally, hold a share of the business. Some shareholders might own more shares than others, which means that they own different percentages of the business (in accounting terms you might see this referred to as their share of the company’s equity).
Owning shares usually means the shareholder is entitled to receive dividend payments from the company’s profits based on the percentage of shares they own. 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 all of the company’s shareholders own the same type of shares, but there might be times when 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 and articles of association as A shares, B shares, C shares and so on, hence the name alphabet shares!
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. A ‘C’ shareholder may not have the same voting rights as a ‘B’ shareholder. This means you could have a variety of shareholders with very different dividend pay outs 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 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 who 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.
Use our online dividend tax calculator to work out what you’ll have left after tax.
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.
Learn more about how we can help with your limited company. Call the team on 020 3355 4047 and get an instant online quote.
FAQs
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.
Are dividends allocated equally to all shareholders? ›
Profits made by companies limited by shares are often distributed 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. Company profits are distributed in proportion to the percentage of shares held by each member.
Can you pay more dividends than retained earnings? ›
In most cases, no, a company can't pay more dividends than it has in profits.
What are the rules for dividend payments? ›
Final dividends require shareholder approval; interim dividends do not. The company has sufficient funds to pay the dividends. Before paying dividends, the company must have enough cash or liquid assets to cover the payments, and the directors must judge that the payment will not cause cash flow problems.
Can shareholders have unequal distributions? ›
The answer depends on what is meant by unequal distributions. If unequal means not equal to each other shareholders, that may be acceptable if there are more than two shareholders with varying percentages of the corporation as stock.
What are the rules for dividends? ›
Section 123(1) of the Act inter-alia states that “no dividend shall be declared or paid by a company for any financial year except out of the profits of the company for that year or out of the profits of the company for any previous financial years”.
How do you distribute dividends to shareholders? ›
Dividends typically are credited to a brokerage account or paid in the form of a dividend check. The dividend check is mailed to stockholders but can be direct-deposited to a shareholder's account of choice, if preferred. The alternative to cash dividends is additional shares of stock.
What are differential rights in dividends? ›
Differential rights shares give the holder differential rights as to dividend, voting or otherwise as compared to someone who owns ordinary shares of a company. This impacts control and decision-making. Differential rights can have: LEGAL BACKGROUND.
Are 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.
What is the accounting treatment for dividends paid? ›
If a company pays a dividend by distributing income from current operations, the transaction is recorded as an operating activity on the cash flow statement. On the other hand, if a company pays a dividend from retained earnings, then it is recorded on the balance sheet as both an asset and liability entry.
First, for a dividend to be paid, there must be profits. A general law principle states that dividends can only be paid out of retained profits. In itself, this is a rather simple test to apply.
What is the maximum dividend that can be paid? ›
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. If the company doesn't have any retained profit, it can't make dividend payments.
Do you have to pay dividends equally? ›
You'll issue the dividends according to the shareholder's class of shares and how much they invested in the company. For example, if a Class B shareholder typically owns 10% of the company shares, they receive 10% of the dividend distribution.
What is the 90 day rule for dividends? ›
In order to receive the upcoming dividend, the holder has to own the shares before the ex-dividend date. The minimum 60-day holding period rule also applies to mutual funds. For preferred stocks, the shares have to be held for over 90 days during a 181-day period that begins 90 days before the ex-dividend date.
What three conditions must exist for dividends to be paid? ›
Therefore, cash dividends reduce both the Retained Earnings and Cash account balances. There are three prerequisites to paying a cash dividend: a decision by the board of directors, sufficient cash, and sufficient retained earnings.
Can shareholders of the same class be treated differently? ›
In general, a company must treat all shareholders equally; however, if a company has different classes of shares, a company can differentiate between the classes.
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? ›
The majority shareholders may agree to be paid less for their shares, while the minority shareholders receive more for theirs. For example, assume a company with one class of common stock whereby the majority shareholders hold 80 shares and the minority shareholders hold 20 shares.
