Director dividends – how to ensure they are legal

In a company limited by shares, dividends are a way for the company to distribute its profits to shareholders. Dividends are typically paid out on a quarterly basis, but can also be paid out annually or on an ad-hoc basis.

The amount of dividends paid out is determined by the board of directors, and is usually a percentage of the company’s profits or a fixed amount per share.

Dividends can be paid in cash or in stock, and are typically taxed as income for the shareholder. Dividends are an important way for shareholders to earn a return on their investment, and can also signal the company’s financial health.

However, it’s important to note that companies that pay dividends may have less money available for reinvestment or expansion, and may therefore have slower growth.

One of the benefits of running a limited company is that Directors can take the majority of their remuneration as dividends, which is typically a more tax efficient method than taking a PAYE salary.

The timing of dividend payments must be carefully considered however, as it can expose directors to risk of personal liability if they’re subsequently found to be unlawful.

We take a look at the requirements for paying a lawful declaration of dividend by a private company.

What is a dividend?

A dividend is a way for a company to return cash to its shareholders. Dividends are a useful (and potentially tax efficient way) of providing additional income to an owner/manager. They can also be used to reward investors or to move money between company groups.

The most common types of dividends are:

• Final dividends – these are paid once a year after the annual accounts have been prepared. Typically they are recommended by the directors and “declared” (approved) by the shareholders.
• Interim dividends – these can be paid at any point during the company’s financial year and are normally declared by the directors.

Declaring a lawful dividend

There are a number of legal requirements that must be met before paying a dividend.

1. The company must have sufficient distributable profits

The Companies Act 2006 requires dividends to be paid out of “profits available for the purpose”. These are the company’s accumulated realised profits less its accumulated realised losses.

Have you made a profit in your company which you are able to take out as a dividend?  If there are insufficient funds to support the payment it will be counted as “ultra vires” -ie not legal. The Companies Act 2006 requires dividends to be paid out of “profits available for the purpose”. These are the company’s accumulated realised profits less its accumulated realised losses.

If the available profits are not sufficient to cover the proposed dividend, then that dividend must not be declared or paid.

2. Dividends must be justified by reference to accounts

The directors need to have a set of accounts that show there are sufficient distributable profits. Dividends must be justified with reference to your prepared accounts to see what profit you have made and therefore whether you have sufficient funds to take as a dividend.

The accounts could be: your company’s last annual accounts; interim accounts or, if the dividend is being declared in the company’s first accounting period, “initial accounts”.  They should however be recent accounts from which you can make an informed decision as to the company’s current financial position.

The accounts must be either:

• The company’s last annual accounts;
• If those annual accounts show that there are insufficient distributable profits, the dividend must be justified by reference to more up-to-date “interim accounts”; or
• If the dividend is being declared in the company’s first accounting period, “initial accounts” must be prepared.

3. The directors must consider the company’s current and prospective financial position

The accounts are only one part of the picture – because they will have been made up to a date before the directors make their decision on whether to pay a dividend. 

Do you have enough cash available to make a dividend payment and when exactly will you pay it? Directors must be satisfied that, even if there remain sufficient distributable profits to pay the dividend, the company still has cash available to be able to meet its ongoing debts and liabilities.

Directors must consider carefully therefore the company’s:

• current financial position at the time of their decision (in case anything has changed since the date of the accounts); and
• future financial position should the dividend be paid. Directors must be satisfied that, even if there remain sufficient distributable profits to pay the dividend, the company will still be able to meet its ongoing debts and liabilities.

The company must also have the cash to pay the dividend. The cash position is relevant to the issues mentioned in this paragraph.

4. Check the company’s articles of association

A company’s articles usually contain provisions about dividends.

For example, it may be that dividends can only be paid on fully paid shares. Or the payment of dividends may be restricted to a certain class of share. Usually, shareholders are entitled to receive dividends in proportion to the number of shares that they hold – but the articles should be checked. The articles may also specify a particular way in which dividends have to be authorised.

5. Comply with directors’ duties

When the directors are deciding whether to declare a dividend they must have regard to their duties. These include duties to:

• act within their powers promote the company’s success for the benefit of its members as a whole;
• exercise reasonable skill and care; and
• declare an interest in the proposed payment (this will be relevant, for example, if a director is also a shareholder).

These duties involve safeguarding the company’s assets (see point 3 above).

6. Dividend voucher

A dividend voucher with your company’s name, date, total amount payable, and details of the shareholders who will receive it, should also be issued to recipients.

7. Document the decision to declare

Directors should ensure that they prepare board minutes recording the process of declaring a dividend. This should include reference to the financial information relied on and the directors’ duties that have been considered. 

The minutes of the meeting as well as a record of the vote need to be kept. These can be provided to HMRC if there is any question in the future about the legality of the distribution of dividends. You also need to record the dividend as a liability.

8. Pay the dividend

Once all these points of process have been followed, the dividend can then be paid! Don’t forget that you can’t retrospectively go through these processes once a dividend has already been issued.

Is there a limit to the number of dividends a company can issue?

There is no specific limit to the number of dividends a company can issue. The decision to issue dividends and the amount to be issued is typically made by the board of directors, and is based on the company’s profits and financial position. However, there are certain factors that a company must consider before issuing dividends.

For example, a company must have enough retained earnings or profits to cover the dividends being issued. Additionally, a company must also consider its financial obligations, such as debt repayment, and must ensure that it will still be able to meet these obligations after issuing dividends. Additionally, some countries have laws or regulations that may limit the amount of dividends a company can issue, but it’s not common.

How are dividends taxed?

The 2022/23 tax year brings certain requirements for taxpayers when it comes to paying taxes on dividends above £2,000.

The following rates apply for the 2022/23 tax year:

• Basic rate taxpayer – 8.75%
• Higher rate taxpayer – 33.75%
• Additional rate taxpayer – 39.35%

However, it’s important to note that while dividends are not subject to Income Tax and National Insurance contributions, they must still be reported in the ‘Dividends’ section of your Self Assessment tax return each year in order to calculate total earnings for the tax year.

On the other hand, if your company is not trading, it can save you time and money on filing annual accounts. Additionally, if your total annual income for the 2022/23 tax year, including dividends, is £12,570 or less, you will not have to pay any dividend tax as your Personal Allowance will apply.

Do I need to issue dividends?

Whether or not you need to issue dividends as a company depends on a variety of factors. Dividends are payments made by a company to its shareholders out of its profits. If your company is profitable, and you have retained earnings or profits available, you may choose to issue dividends to your shareholders as a way to distribute those profits.

However, it’s important to consider the financial position of your company, as well as your future business plans before issuing dividends. Additionally, you should also consult with your legal and financial advisors and review any legal and regulatory requirements that may apply to your company. Ultimately, the decision of whether or not to issue dividends should be based on a careful consideration of the company’s financial situation, strategic goals and legal compliance.