When are dividends unlawful?

Do you know how to deal with dividends in accordance with the Companies Act as a director?

In this blog, we’ll explore a recent case demonstrating how HM Revenue & Customs (HMRC) will go back to the source of information and transactions in deciding whether a payment should be taxed as a dividend or as salary.

We’ll also highlight what clients need to do going forward, with a particular focus on digital accounting software.

Case study

Regardless of company structure, dividend payments are unlawful when insufficient profits exist to cover the amount paid.

This was recently upheld in the case of Global Corporate Ltd v Hale, in regards to the rules regulating the payment of dividends to shareholders in the event of liquidation.

Between 24 June 2014 and 26 October 2015, payments described as ‘dividends’, which totalled £23,511, were paid by Global Corporate Ltd to the now former director, Mr Hale, despite the company having insufficient profits to cover the payments.

Global Corporate Ltd argued that the director was responsible for taking the dividends, and therefore owed the company and its creditors.

However, the court ruled that it was, in fact, the company who should take responsibility for the repayment of the dividends, as “companies must have sufficient reserves to pay dividends at the time they pay them, whether or not they intend to rectify any deficiency at the end of a tax year”.

It means that Global Corporate Ltd now must cover the payments despite having paid it out to a director some years previously.

So, what do clients need to do?

With the introduction of Making Tax Digital (MTD) for VAT, business owners are increasingly taking greater control of their finances. Technology has allowed us to scrutinise, analyse and present information better than ever before, which is only a good thing where the tax authorities are concerned.

Therefore, to take better control of your dividend payments, we advise business owners to:

  • Run a quarterly or monthly Profit & Losses (P&L) / balance sheet.
  • Assess your reserve position and decide whether to declare a dividend. Include accompanying board minutes and dividend vouchers (get in touch with your McGills accountant if you do not have access to these).
  • Run payment or journal to Director’s Loan Account (DLA).

Evidencing this should suffice the authorities in the event of an investigation. For more help and advice, please get in touch with our expert team.