Unlawful dividends occur when money is withdrawn from a limited company without adequate profits to support it.
Shareholders who receive unlawful dividends may be required to repay the money if they were aware that the company couldn’t afford such distributions.
Directors may be held accountable for repaying not only their own unlawful dividends but also those made by the company.
Understanding unlawful dividends for company directors
Running a limited company offers the benefit for directors to receive a significant portion of their remuneration as dividends, often a more tax-efficient method compared to a salary through PAYE.
However, careful consideration of the timing of dividend payments is crucial, as it can expose directors to personal liability if found to be unlawful. Prior to any dividend payment, it is essential to ensure that there are ample profits in the company to support it.
The rules governing dividend payments stipulate that if there are insufficient distributable profits to back the payment, it will be considered ‘ultra vires,’ meaning ‘beyond the powers.’ In essence, directors lack the authority to authorize such payments under these circumstances.
When should a corporation pay dividends?
The Companies Act, 2006, outlines the rules for dividend payments. Dividends can only be issued from distributable profits; thus, they would be considered illegal if there are inadequate funds available to cover them.
Directors are required to refer to the statutory accounts for the period preceding the distribution. However, preparing current interim accounts can sometimes provide greater confidence in verifying the legality of the dividend.
Additional considerations before taking dividends from a company
Before a dividend payment can be considered lawful, several conditions must be met:
- A board meeting should be held to assess the level of distributable profits available and formally declare the dividend. Minutes from this meeting can be provided to HMRC if questions arise in the future about the legality of the distribution.
- A dividend voucher containing the company’s name, date, total amount payable, and details of the shareholders receiving it should be issued to recipients.
- Seeking professional guidance before declaring a dividend is advisable. Using an incorrect figure from the company’s accounts can be an issue when determining if a dividend can be paid. Moreover, corporation tax must be deducted from the company’s profits to arrive at the figure for distributable profit.
Poor administrative processes, such as unreliable or incomplete information on the company’s financial situation, can lead to the payment of illegal dividends. Providing authorization after the fact for a dividend that has already been issued is considered fraudulent.
Tax issues and declaring dividend income
Individuals benefit from a tax-free dividend allowance of £2,000 annually. Dividends below this threshold are not subject to income tax. Dividends exceeding £2,000 are taxed based on the individual’s tax band.
- Basic rate taxpayers face a 7.5% tax.
- Higher rate taxpayers incur a 32.5% tax.
- Additional rate taxpayers experience a 38.1% tax.
Individuals receiving over £10,000 in dividend income must complete a self-assessment tax return. Tax on income below this can be paid by requesting HMRC to adjust the tax code.
Notably, companies do not pay corporation tax on dividend payments since it has already been deducted from the gross profit figure.
Repaying an unlawful dividend – who is ultimately liable?
Under the Companies Act, 2006, individuals receiving an unlawful dividend may be obligated to repay the amount. Shareholders become liable if they were aware that the company couldn’t support the payment when it was issued.
In cases where shareholders are genuinely unaware of the company’s financial position or if there is a substantial shareholder base, it may not be practical to recover dividend payments in this manner. Consequently, liability may shift to the director(s) who authorized the payment. Directors may then become responsible not only for repaying their own unlawful dividends but also for those distributed to other shareholders.
Unlawful dividends and insolvency
For directors, the risks associated with issuing unlawful dividends significantly escalate if a company enters insolvency, irrespective of whether their payment contributed to the company’s financial decline. In cases where the company needs to be closed down and liquidated, a licensed insolvency practitioner is appointed to gather the company’s assets for distribution to creditors.
As part of the liquidator’s responsibilities, they scrutinize payments made to shareholders in the years leading up to insolvency, aiming to identify potentially illegal transactions, including dividend payments.
If there are concerns about a dividend payment being considered unlawful, Business Insolvency Helpline can provide assistance. Their licensed insolvency practitioners offer extensive experience and can provide advice on the associated risks. They work promptly and can arrange a free same-day meeting to discuss the situation.
In cases of company insolvency, the possibility of repayment may arise upon request by an Insolvency Practitioner. If you encounter issues related to dividends and seek guidance or solutions, do not hesitate to reach out to us at 01246 912052. We possess extensive expertise in insolvency matters and are well-equipped to assist you.
With over three decades of experience in the business and turnaround sector, Steve Jones is one of the founders of Business Insolvency Helpline. With specialist knowledge of Insolvency, Liquidations, Administration, Pre-packs, CVA, MVL, Restructuring Advice and Company investment.