Updated: 17th January 2021
There are various ways for directors to take money out of their limited company. One of the most popular methods of drawing down funds is by issuing dividends to shareholders. Often taken in conjunction with a low basic salary paid through PAYE, dividends are one of the most cost-effective and tax-efficient ways of paying yourself as a company director.
The key with dividends is that they should only be taken from company profit. Before declaring a dividend, you need to be sure that the company can afford this once you have accounted for all outgoings including the corporation tax which will be due on profits.
If it later transpires that the company was not in a position to issue the amount of dividends they have, these will subsequently be classed as ‘illegal’ or ‘unlawful’ dividends, sometimes known as ultra vires dividends.
In many instances, declaring an unlawful interim dividend is an honest mistake, whereby upon reconciling the company’s profit at the end of the accounting period, directors find that actual profit is not at the level which was anticipated at the time when the dividends were announced. This could be due to a multitude of reasons such as a lengthy period of illness, a sudden drop in sales, or unexpected operational challenges which negatively impacted on financial performance.
In other instances directors may have simply miscalculated matters and declared dividends based on the company’s bank balance rather than after-tax profits.
While this is not an ideal position to be in, rest assured that declaring illegal dividends is not considered a criminal offence, and there are ways of correcting your mistake and ensuring your company’s finances are brought back in line.
Once declared dividends have been paid, they cannot then be cancelled even if they are found to be unlawful. Instead the amount issued should be treated as a loan from the company. As is the nature of a loan, the shareholder is required to pay these funds back to the company in a timely manner.
In instances where the recipient shareholder also holds the position of company director, then directors’ loan account benefit in kind charges will apply to loaned amounts in excess of £10,000. Should the loan remain outstanding beyond 9 months following the company’s year-end date, a 32.5% charge will be levied on the outstanding balance; it will also be subject to corporation tax. This charge is known as a section 455 tax and this can be reclaimed once the loan has been cleared in its entirety.
Things are different when it comes to a shareholder who is not a director. In this instance, unless the shareholder knew, or was reasonably expected to believe, that there would be insufficient distributable reserves then they will typically not be required to pay the dividend back.
So while repaying an illegal interim dividend is a relatively straightforward matter if you are still in receipt of the funds, what happens when paying the money back is not possible immediately?
If the error comes to light several months after the dividend was declared, it is likely the dividend taken from the business has now been spent. The simplest course of action at this stage is likely to be to use future sales to generate adequate enough money to bring the company back to a profitable position. However, it is always worth seeking advice from your accountant if you are in this position.
If you find yourself in a position where your limited company has declared an illegal dividend, you need to consider the underlying reasons behind why this has happened. In some case, taking too much dividend could hint at deeper problems within your company.
If your company’s profit was substantially lower than you were expecting, this could point to cash flow problems, a subdued marketplace, and even potential insolvency in the worst cases. If you fear taking excess dividends was the result of more than just a miscalculation, your company could be in trouble. If you believe this to be the case it is vital that you seek the advice of a licensed insolvency practitioner as a matter of urgency.
Begbies Traynor is the UK’s number one business rescue and recovery specialists and have been helping limited company directors experiencing financial distress for over 30 years. Call our expert team today on 0800 063 9221 to arrange a free no-obligation consultation with a licensed insolvency practitioner at any one of our 70+ offices up and down the country.