What are unlawful dividends and what are the penalties?
According to the Companies Act 2006: ‘a dividend or distribution to shareholders may only be made out of profits available for the purpose’. For the distribution of dividends, company directors must refer to:
- Last annual accounts
- Alternatively, interim accounts if the company cannot justify dividends from annual accounts
- Reference initial accounts
Difference between legal and unlawful dividends
We do recommend preparing up-to-date interim accounts for greater confidence in distributing the company dividends. It’s important to note that your dividends do not need to be filed, but public companies will have to do so with Companies House before distributing.
The formalities regarding unlawful company dividends are strictly enforced, and can even result in personal liabilities for directors. In the case of insolvency, they will be extensively scrutinised by the liquidator or administrator. You may even be found liable for declaring an unlawful dividend if profits were found elsewhere in the company. Similarly, even a ‘technical’ error can result in the declaration, so you must take the considerations into account before taking remuneration.
Are there different types of dividends?
There are several types of dividend. The most common form is the cash dividend. However, another type of dividend is the transfer of a company asset, known as distribution in specie. In some cases, many directors may not realise the same rules apply to the company asset where it has a book value and, therefore, fall foul of the Companies Act 2006. If you do happen to take a salary through a regular dividend, you must ensure the profits can support this. If not, you may be liable for National Insurance and other tax.
What circumstances may cause unlawful dividends?
Before we begin, we advise seeking professional guidance before declaring a dividend. Simply using an incorrect figure when calculating the payment can result in an illegal payment. Stating that you were unaware of the rules regarding dividends is also not a reasonable excuse, and you may still be held responsible for director liabilities.
There are several circumstances in which a payment may be made unlawfully:
- As mentioned above, the use of an incorrect figure or miscalculation of company profits can lead to illegal dividends.
- Failure to maintain accurate company accounts and keep records.
- Technical error when declaring the payment.
- Lack of knowledge regarding the transfer of company assets.
- Backdating previously issued company dividends.
When declaring dividends, it’s no longer necessary to hold a board meeting. However, this is solely dependent on your company’s Articles of Association. If allowed, directors can declare interim dividends without the need to consult the board. Generally, however, dividends are only payable when passed by the company shareholders. The board meeting minutes must be recorded to demonstrate the agreement, also detailing the members present and amount. Similarly, the following details must be included on the dividend vouchers for shareholders:
- Company name and number
- Number of shares held by the shareholder
- The date, name and address of the shareholder receiving the dividend
- Amount of payment
- Amount of associated tax credit – 10% of the total dividend amount
- Signature of director
Directors must refer to the ‘relevant accounts’ to determine existing and supporting profits. These will be the last statutory accounts for the period immediately preceding the distribution. However, as mentioned above, you may need to prepare interim accounts. The legality of your dividend is dependent on the accuracy of these calculations. Therefore, it may be worthwhile to have an accountant check the validity.
The consequences of insolvency
In the case of company insolvency, issuing unlawful company dividends is particularly problematic. Doing so places directors at serious risk of personal liabilities. While those in receipt of the payments may not know it is unlawful, the directors will shoulder the responsibility for issuing the payment.
During insolvency procedures, the liquidator or administrator must scrutinise all payments made to shareholders. They will be appointed to collect and recoup company assets for creditors, and they will look to identify any illegal payments. Similarly, directors could be at risk of breach of director duties. The role of a director is to promote the success of the company, and making illegal payments could be seen as in the interest of the directors, rather than the business.
Paying back the dividends
Remedying the payment of an unlawful dividend can prove costly and time-consuming. In the case of insolvency, the likelihood of shareholders required to repay the dividend is greater. Shareholders for smaller companies should, typically, know if there are sufficient profits, making it slightly easier to gain a repayment.
However, if the shareholder is not obliged to repay, it’s likely the directors will be personally liable.
Paying unlawful dividends can lead to significant consequences for directors – especially if HMRC believe the payment should be treated as salary. If you require advice for issuing the declarations or even believe your company may be heading to insolvency, our business rescue experts can provide helpful and knowledgeable advice.