Guide to illegal dividends
As all owner-managed business owners know achieving a tax efficient remuneration mix is of paramount importance and dividends have an important part to play. Typically their salary is drawn through the PAYE system with the larger amount being drawn monthly as dividends and accounted for when the year-end accounts are prepared. It is therefore crucial that the proper procedures are in place before funds are paid to shareholders.
What is a Dividend?
A company may only make a distribution of its profits available by way of a dividend; which is normally classified as accumulated realised profits less accumulated realised losses. A distribution cannot be made out of capital. Therefore a company must make sure that it has sufficient retained profits to allow the dividend to be paid. Where dividends exceed these retained profits the dividend is unlawful and cannot be classified as such.
The statutory provisions relating to declaring and paying a dividend are contained in Part 23 of the Companies Act 2006 (“Act”).
Who Declares a Dividend?
The directors normally declare the payment of a dividend, with or without shareholder approval. It can be made at the end of the financial year, however, is quite usual to declare a series of interim dividends.
When should a Dividend be declared?
The company’s last annual accounts will determine whether there are sufficient distributable reserves to enable a dividend to be made except in two circumstances:-
• Where the proposed distribution exceeds the amount of the distributable reserves the dividend may be justified by interim accounts, which do not need to be audited.
• Where the proposed dividend is declared during the company’s first accounting period.
A reasonable judgement must be made of the company’s profits, losses, assets, liabilities and other relevant financial factors when declaring interim dividends.
The board of directors needs to minute the declaration of a dividend which needs to details:-
• The accounts (annual / interim) being used as the basis of the dividend.
• The company’s solvency (it should not hinder trade or ability to pay liabilities).
• The relevant shareholders who are to receive the dividend.
• The amount and the date of the dividend.
The penalties for getting it wrong?
The law must be strictly complied with for a declaration and distribution of a dividend to be lawful. The courts will not hesitate to declare unlawful a dividend that has not been made in accordance with the rules.
When a dividend has been made that is not in accordance with Act the shareholder is liable to repay it to the company under Section 847 of the Act and whilst the court may grant relief to the shareholder it will do so only if it does not benefit the shareholder at the expenses of creditors.
It may be on some occasions that such payments may be treated as loans to the directors. However, as a consequence of reclassifying the overpayment of a dividend to an overdrawn loan account HM Revenue & Customs may look to charge income tax and national insurance to the director personally on the value of the loan as a benefit in kind.
And there is more!
One of our duties as Liquidators is to see what has happened in the lead up to insolvency. Have payments been made preferentially to creditors; what transactions at undervalue have taken place prior liquidation. And one of the aspects of our investigations is a review of the bank statements that highlight what the director/ shareholders have been paid during this period. Once we have checked to see if dividends have been drawn we then check the statutory records to see if the dividends have been declared properly.
One of the arguments used in the past was that any payments taken were salary or a bonus that ought to have been declared on the PAYE returns but now with real time monthly reporting to HM Revenue & Customs is in place there can be no “backdating” of correcting an overpayment in dividends.
The actions of the director/ shareholders in drawing funds from the company to the detriment of creditors will be reported under the requirements of the Company’s Directors Disqualification Act 1986 and may lead to disqualification as a director for a period of time.
If the funds are not repaid then the liquidator may be forced to take action for misfeasance of the fiduciary duty of the director/ shareholder under Section 212 of the Insolvency Act 1986 to order that the overpayment is restored to the company with interest.
One more dire consequence that has been reported recently is the use of Section 206 of the Insolvency Act 1986, which could lead to a criminal record. This section makes it an office for an officer of the company to … remove property… within 12 months immediately preceding the commencement of winding up and renders a person liable to imprisonment or a fine or both.
It is therefore imperative that you take proper advice and you must ensure that you keep proper records and our specialist licensed insolvency practitioners offer a free initial consultation during which they will provide an unbiased assessment of the business financial situation, explore all available options to help directors navigate a cost-effective and lawful way out of their financial difficulties.
To discuss how RNF Business Advisory could help – please contact us at firstname.lastname@example.org
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