Reviewed: 26th September 2017
One of the benefits of running a limited company is that directors can take the majority of their remuneration as dividends, which is 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.
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.
Real Business Rescue can provide guidance on the payment of dividends, and whether directors are at risk of acting unlawfully. We offer same-day consultations free-of-charge from offices nationwide.
Other conditions also have to be met before a dividend payment can be considered lawful:
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.
The tax rules relating to directors’ dividends changed in 2016, when a new tax-free dividend allowance of £5,000 was introduced. From 6th April 2018, this annual allowance will reduce to £2,000.¹
Dividends over the current threshold of £5,000 are taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers, and 38.1% at the additional rate. From April 2016, basic rate taxpayers who receive more than £5,000 in dividend income will need to complete a self-assessment tax return.
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.
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 shareholders.
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 liquidation is inevitable, a licensed insolvency practitioner (IP) will be appointed to collect in the company’s assets.
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, including illegal 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 55 offices nationwide, and will arrange a free same-day meeting to discuss your situation.
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