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What Are Unlawful Dividends

What Are Unlawful Dividends. Written by John A Waller. Director. Reviewed November 20th,2022.

Understanding What are unlawful dividends 

Unlawful dividends occur when a company pays out dividends despite insufficient profits. Shareholders who take an illegal dividend may need to repay it if they know the company can’t afford it. The directors of the company may be held responsible for not only their own, but also for all illegal dividends made by their company.

Many directors, when challenged about unlawful dividends, say my accountant asked me to do it. However, directors remain responsible for their actions and must be aware of directors duties and responsibilities.

Ways for an unlawful dividend to happen:

  • Insufficient profits;
  • Paying dividends without regard to the financial position;
  • Backdating dividends;
  • The company remained insolvent when paying the dividend;
  • Not properly declared;
  • Cash withdrawn without being correctly identified.

Understanding illegal dividends for company directors

Directors of limited companies can receive part of their remuneration as dividends, which is more tax efficient than a salary via PAYE.

Timing dividend payments is important. Not doing so risks the company director’s liability. Before considering a dividend payment, ensure the company retains sufficient profits to enable the transaction.

The rules for dividend payment state that if there are insufficient distributable profits to warrant payment, then any payment shall be considered “ultra vires,” which means “beyond the powers.” In other words, directors have no such authority under these circumstances.

What Are Unlawful Dividends – When should a limited company pay dividends?

The 2006 Companies Act covers dividend rules. Directors can only make dividends from available profits. Insufficient resources would make it illegal.

Directors must refer to the company’s accounts for the period before distribution. Up-to-date interim accounts can provide greater confidence in the legitimacy of the dividend.

As a company director, understand the reasons businesses become insolvent?

Additional factors to consider before paying dividends from a company as a director.

Other conditions must also be met for a dividend payment to be lawful:

  • Hold a board meeting to consider the level of distributable profits and ‘declare’ the dividend. The minutes can be given to HMRC if any questions arise about the legality of distribution.
  • A dividend voucher displaying: –
    • company’s name;
    • date;
    • amount;
    • Recipients Name.

Directors must seek professional advice before declaring a dividend. An incorrect figure from the company’s accounts often causes a problem in determining whether a director can pay a dividend. Additionally, directors must deduct corporation tax from the company’s profits to determine the distributable profit figure. 

Poor admin and inaccurate, late financials can cause illegal dividends. Untrustworthy. Additionally, authorisation for a dividend already issued remains fraudulent.

Tax issues and declaring dividend income

Individuals have a tax-free dividend allowance of £2,000 a year, which means dividends below this amount are not subject to income tax. Dividends above the £2,000 threshold remain taxed according to the individual’s tax band.

Shareholders who receive £10,000 or more in dividend income must disclose this on their self-assessment tax return. 

Limited companies do not pay corporate tax on dividend payments, as they remain deducted from gross profit.

Repaying an unlawful dividend – who is responsible?

As per the Companies Act of 2006, the recipient of an unlawful dividend may have to pay back the money taken. Shareholders of the company face liability if they understand the company cannot sustain the payment when actioned.

Some shareholders may not know the company’s financial circumstances, and it might be impossible to recover if a significant shareholder base exists.

Directors who authorised the payments may be deemed liable for repaying their unlawful dividends and those distributed to other shareholders.

Unlawful dividends and insolvency

The risk of unlawful dividends as a director increases significantly when a company enters insolvency, whether its payment caused its financial downfall. Having an overdrawn Directors Loan Account and liquidation in process means the appointef licensed insolvency practitioner (IP) must collect the company’s assets so that creditors can receive a distribution from the liquidator. An overdrawn directors loan account is an asset of the company in liquidation.

Once appointed, the liquidator undertakes to: –

  • Realise the assets of the company; 
  • Investigate how the company operated and managed by the directors before their appointment;
  • Examine financial transactions authorised by a director, including those to shareholders and directors.
  • Ensure realised funds remain distributed in the statutory order of priority to creditors.

So, if you’re concerned about unlawful dividend payments, HBG Advisory can help. Our experienced team of licensed insolvency practitioners advise company directors on their vulnerability. We provide a free initial same-day meeting to discuss your company’s financial position.

What are unlawful dividends? – How can illegal dividends be corrected?

Having paid yourself an illegal dividend, provided it remained an interim dividend, the simplest way to amend it remains to repay the money. 

Correcting an unlawful dividend once a company remains in liquidation requires the liquidator to determine through their investigation whether dividend payments were paid when the company retained insufficient distributable profits so that the liquidator  demands repayment back to the company. The investigations remain part of the duties of an insolvency practitioner.

Failing To Declare The Dividend

The payment of a dividend without declaration means it remains not a dividend. So the failure to declare the dividend means the transaction may need to be reversed and paid back.

Tax implications paying Unlawful Dividends

Paying unlawful dividends may impact your corporation tax and therefore lead the company into trouble with section 455 Corporation Tax issues, possibly increasing your corporation tax liability. Therefore, creates an overdrawn director’s loan account.

Can directors refuse to pay dividends?

A limited company legally does not have to declare dividends. Directors may take this action if they consider it to be in the best interests of the company.

What is a dividend waiver?

Dividend waiver: – shareholders voluntarily waive their share of the dividend, allowing distributable profits to be distributed to remaining shareholders in proportion to their holdings.

Bounce Back Loan advice for Company Directors

Directors should seek professional advice if they have Bounce Back Loan worries regarding repayments. The UK government introduced the COVID-19 support scheme to support businesses through the pandemic. However, repaying the loans has been difficult. So ensure you seek advice sooner than later.