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Dividends are unlawful when insufficient profits exist within the company to cover the amounts paid. Rules regarding the payment of dividends are laid down in the Companies Act, 2006 which states, “a dividend or distribution to shareholders may only be made out of profits available for the purpose.”

Additionally, a dividend may be deemed illegal if:

  • Authorisation has not been provided in the correct format: minutes from a board meeting held to sanction the release of a dividend should confirm directors’ consideration of profit levels available prior to authorisation being given. Even if you are a sole director, these minutes are needed to satisfy HMRC requirements.
  • A dividend voucher has not been completed: this is a ‘receipt’ for tax purposes. It should show the dividend rate per share, dividend figure, and the amount of tax credit.

A term sometimes used to describe an illegal dividend is ‘ultra vires,’ which means ‘beyond the powers.’ In other words directors do not, in reality, have the power to authorise such a payment from company funds.

Dividends deemed illegal by HMRC may be classified as salary, on which National Insurance and tax becomes due. Therefore, if you take a regular dividend in this way, you need to ensure that company profits can support the payment on each occasion.

In what circumstances might dividends be paid illegally?

  • Miscalculation of profits or the use of an incorrect figure sometimes leads to illegal dividends being issued, as can failure to complete board meeting minutes and the dividend voucher described above.
  • Poor record-keeping could easily lead to their issue, both in terms of the administrative and financial paperwork required prior to authorisation.
  • It would be considered a fraudulent activity by HMRC to backdate authorisation for previously issued dividends. If this was discovered, penalties and/or fines would be applied.

Declaring lack of knowledge or awareness of the rules surrounding dividend payments does not exclude you from being held personally liable for business debt as a company director.

Up-to-date and accurate profit figures on which to base authorisation

The latest year-end accounts may not be appropriate when establishing current distributable profit levels. You will need to prove that sufficient profit exists within the company before payment of a dividend is made, either by reference to real-time information within online management accounts, or by preparing interim accounts.

The legality of dividends rests on the accuracy of these calculations, and you may prefer to ask your accountant to prepare the accounts or to check their validity. They should show sufficient profit available to cover the payment after all the appropriate liabilities have been deducted. In other words, “accumulated realised profits less ... accumulated realised losses.”

Begbies Traynor can offer guidance on matters such as these to ensure directors remain compliant with regulations, and are not at risk of personal liability. We offer same day consultations from offices nationwide.

What happens if your company becomes insolvent?

The obligation for directors to act in a proper manner places them at serious risk of liability should the company become insolvent. If a dividend has been paid unlawfully, it may not have been apparent to those making or in receipt of the payment, but does not alter where liability is placed, i.e. on the shoulders of directors.

A healthy cash flow and existing profits sometimes lead to a mistaken sense of security. Directors working under a genuine belief that their company is solvent, may find on further investigation that a future liability such as Corporation Tax projects a different picture, and places the company in an insolvent position.

What are the potential repercussions for company directors?

HMRC will argue that you knew or should have known a dividend was illegal. It is a duty in directorship to be aware of your company’s financial position at all times, and responsibility for this stops with the directors.

This obligation becomes an inherent part of insolvency. Continuing to trade whilst insolvent, however well-meaning your actions as a director, is a serious offence that fails to put creditor interests first.

When insolvency is combined with the payment of unlawful dividends, directors will face huge pressure to justify their actions on both counts. It is imperative that you consult a professional Insolvency Practitioner for advice should you fear approaching insolvency and/or the issue of illegal dividends.

Begbies Traynor is the leading UK business recovery practice, and with an extensive UK office network can arrange a same-day meeting free of charge. We offer guidance in situations such as this, and are available for appointment as administrators.

An unlawful return of capital to shareholders

Should the company become insolvent and a shareholder who has received an unlawful dividend is not legally obliged to repay it, the Official Receiver or practitioner liquidating the company’s assets will pursue the director(s) for payment.

This risk of exposure to legal action significantly increases if a position of insolvency is reached. So is there anything that can be done to mitigate the risk once an unlawful dividend has been recognised?

  • An explanation can be added to the dividend note addressing the fact that a shareholder has received an illegal dividend, and that steps are being taken to recover the money.
  • Additional reference may be made to directors’ understanding that no further dividend payments must be made until the situation is resolved.

Paying dividends unlawfully has serious ramifications for directors, and not only in relation to insolvency. If HMRC believes that a dividend should be treated as salary, they are likely to be relentless in pursuit of the relevant NIC and tax payments. Following a set administrative procedure prior to authorisation and issue may be your only defence.

Begbies Traynor is the number one corporate recovery firm in the UK. Contact a member of our expert team to discuss your options.

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Insolvency Practitioners Association Institute of Chartered Accountants in England and Wales R3: Association of Business Recovery Professionals ICAEW Business Advice Service Turnaround Management Association ACCA (the Association of Chartered Certified Accountants) ICAS | The Institute of Chartered Accountants of Scotland