How to Handle and Distribute Profits in a Limited Company

One of the biggest advantages of running a limited company is the flexibility you have over how profits are retained, reinvested, or distributed to shareholders. This control is a major draw for business owners but it also comes with clear legal responsibilities. As a company director, you must follow the rules set out in the Companies Act 2006 and ensure all profit distributions are made correctly, backed by proper accounts, and compliant with HMRC guidance.

This guide breaks down how limited company profits work in the UK, the different methods for distributing them, and what you must consider before paying yourself or any other shareholder. We’ll also cover practical tax-efficient strategies, record-keeping essentials, and common mistakes small companies make when handling profit distributions.

Whether you’re a new director or looking to improve how your business manages its earnings, this overview will help you make informed decisions, avoid penalties, and keep your company running smoothly.

In this post, you’ll learn:

• What counts as distributable profits
• The rules around dividends and how to issue them legally
• How retained profits support company growth
• Tax considerations for directors and shareholders
• Practical steps to stay compliant with HMRC and Companies House

Tip: Before declaring any dividend, make sure your bookkeeping and management accounts are fully up to date. HMRC may challenge incorrect or unlawful dividends, and directors can be required to repay them personally.

How Do Limited Company Profits Work?

When your company generates income, it must first cover all allowable business expenses. These are costs that are “wholly and exclusively” for business purposes, as defined by HMRC. Typical expenses include:

• Day-to-day operating costs (e.g. office supplies, travel, software)
• Staff salaries, employer National Insurance and pension contributions
• Overheads such as rent, utilities, equipment and professional services

Once these costs are deducted, you’re left with your profit before tax – also known as your taxable profit. This figure is crucial, as it forms the basis of your Corporation Tax calculation.

Corporation Tax on Company Profits

All UK limited companies must pay Corporation Tax on their taxable profits. For the 2025/26 tax year, the rates are:

• 19% on profits up to £50,000
• 25% on profits over £250,000
• Marginal Relief applies to profits between £50,000 and £250,000, gradually increasing the effective rate

If your company is part of a group or has “associated companies”, these thresholds may be reduced – a detail often overlooked by small businesses.

After paying Corporation Tax, the remaining amount is your company’s post-tax profit. Directors and shareholders have two key options for how this profit is used:

• Distribute it (typically through dividends)
• Retain it within the company to support growth, manage cash flow or build reserves

Both choices carry strategic and tax implications, which we explore in later sections.

Tip: Keep your bookkeeping up to date throughout the year. Inaccurate or delayed accounts can lead to over- or under-payment of Corporation Tax and may make dividend distributions unlawful.

Ways to Distribute Profits in a Limited Company

Once your company has post-tax profits, you can choose how to distribute or use them. Each option has different tax implications, legal requirements, and strategic benefits for directors and shareholders.

1. Dividends

• Dividends can only be paid from distributable post-tax profits – never from projected or future income.
• Directors must formally declare dividends at a board meeting in line with the Companies Act 2006.
• Every dividend must be supported by:
  • A dividend voucher (confirmation for the shareholder)
  • Board minutes approving the payment
  • Up-to-date accounts proving sufficient profits
• Shareholders pay tax at dividend tax rates, which are usually lower than PAYE Income Tax.

Tip: Paying dividends without enough distributable profit is considered an “illegal dividend”. Directors may have to repay the amount personally – so accurate accounts are essential.

2. Salaries and Bonuses

• Directors can be paid a salary through the company’s PAYE payroll system.
• Salaries and bonuses count as allowable business expenses, reducing the company’s Corporation Tax bill.
• Bonuses are subject to Income Tax and both employer and employee National Insurance.
• Many small companies use a tax-efficient mix:
  • Low salary (using the personal allowance and NI thresholds)
  • Dividends on top, to minimise NI costs

Note: The optimal salary level changes each tax year. Check HMRC’s current thresholds or speak to an accountant to ensure you remain compliant.

3. Pension Contributions

• The company can make employer pension contributions directly to a director’s pension.
• These contributions are usually treated as an allowable business expense, reducing Corporation Tax.
• They are not subject to Income Tax or National Insurance, making them a highly tax-efficient way to extract profit.
• Contributions must be “wholly and exclusively” for business purposes – generally satisfied when the director is actively working in the company.

Tip: Pension contributions often outperform dividends for long-term tax planning. Use HMRC’s annual allowance rules to maximise relief.

4. Reinvestment

• Companies are not required to distribute profits – retaining them can strengthen cash flow and future growth.
• Reinvesting profits into equipment, technology, staff training, R&D, or marketing can improve long-term profitability.
• Some investments may qualify for tax relief schemes such as the Annual Investment Allowance (AIA) or R&D tax relief.

Tip: Building up a cash reserve can help your business stay resilient during periods of uncertainty or seasonal fluctuations.