Unlawful dividends are where money is extracted from a limited company when there are insufficient profits to allow for this. Shareholders in receipt of an unlawful dividend may be asked to repay this money to the company if they were aware the company could not afford to make this distribution. Alternatively, directors may be held responsible for repaying not only their own, but all unlawful dividends made by their company.
Understanding unlawful dividends for company directors
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 salary solely via PAYE.
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. Before any dividend payment is made, it must be ascertained that there are enough profits in the company to allow for this.
The rules for paying dividends state that if there are insufficient distributable profits to support the payment, it will be regarded as ‘ultra vires’ which means ‘beyond the powers.’ In other words, directors have no such power of authorisation under these circumstances.
The Companies Act, 2006, lays out the payment of dividend rules. Dividends can only be made from distributable profits, so would be deemed illegal if there are insufficient funds available to cover them.
Directors must refer to statutory accounts for the period before the distribution is made, but preparing up-to-date interim accounts sometimes offers greater confidence in establishing the legality of the dividend.
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Additional considerations before taking dividends from a company
Other conditions also have to be met before a dividend payment can be considered lawful:
A meeting of the board should be held to consider the level of distributable profits available, and to ‘declare’ the dividend. The minutes of this meeting can be provided to HMRC if there is any question in the future about the legality of the distribution.
A dividend voucher with the company’s name, date, total amount payable, and the shareholders in receipt, should also be issued to recipients.
It’s advisable to seek professional guidance prior to declaring a dividend. Using an incorrect figure from the company’s accounts is sometimes an issue when calculating whether a dividend can be paid. Additionally, corporation tax must be deducted from the company’s profits to arrive at the figure for distributable profit.
Poor administrative processes can also lead to the payment of illegal dividends - if up-to-date information on the company’s financial situation is sketchy or unreliable, for example. It’s also worth noting that providing authorisation in hindsight, for a dividend that’s already been issued, is regarded as fraudulent.
Tax issues and declaring dividend income
Individuals are given a tax-free dividend allowance of £2,000 a year, meaning any dividends taken under this amount will not be subject to income tax. Dividends in excess of this £2,000 threshold will be taxed according to the individual’s tax-band.
Tax is levied at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers, and 38.1% at the additional rate. Individuals who receive more than £10,000 in dividend income will need to complete a self-assessment tax return; tax can be paid on income below this by asking HMRC to amend their tax code.
It’s also worth noting that companies don’t pay corporation tax on dividend payments, as it’s already been deducted from the gross profit figure.
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Repaying an unlawful dividend – who is ultimately liable?
Under the Companies Act, 2006, the recipient of an unlawful dividend may be required to repay the amount. Shareholders become liable if they know the company was unable to support the payment at the time of issue.
Some shareholders may be genuinely unaware of the company’s financial position, however, or if there is a particularly large shareholder base it may not be practical to recover dividend payments in this way.
This passes liability to the director(s) who sanctioned payment. Directors may then become liable, not only for repaying their own unlawful dividends, but also for those distributed to other shareholders.
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Unlawful dividends and insolvency
For directors, the dangers of issuing unlawful dividends increase considerably if a company enters insolvency, whether or not their payment caused the company’s financial decline. In cases where the company needs to be shut down and liquidated, a licensed insolvency practitioner (IP) will be appointed to collect in the company’s assets so that they can be distributed to creditors.
Part of the liquidator’s role is to scrutinise any payments made to shareholders during the years leading up to insolvency, with a view to identifying certain transactions which may have been illegal, including dividend payments.
If you’re worried about a dividend payment that may be regarded as unlawful, Real Business Rescue can help. Our licensed insolvency practitioners have extensive experience and can advise on your exposure to risk. We work from, and will arrange a free same-day meeting to discuss your situation.
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