Can you afford to make a dividend?

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A reminder of what is and isn’t a lawful dividend

Even though we appear to be returning to ‘normal’ thanks to the global pandemic, we are not out of the woods just yet.

Many businesses are currently trying to pick themselves up from the effects of the last 18 months but the very present risk of corporate and personal insolvency is very much something to be kept at the front of people’s minds.

Therefore, it is worth refreshing your memory as to the position in respect of Company Dividends and when it is appropriate for them to be paid out.

There are obvious tax advantages to dividend as they attract a lower rate of income tax when compared to a usual salary. However, in view of the benefit of receiving a dividend there are serious considerations to be made before these are paid out as it can expose the directors and shareholders of the company personally if it is later found that the dividend was paid unlawfully.

Process for Lawful Dividend

Before paying a dividend there are certain legal requirements that have to be met by the company, in particular the directors must be satisfied that the company has sufficient distributable profits to pay the dividends i.e. the company must have profits available for the purpose of paying out dividends (s.830 Companies Act 2006).

In order to ascertain whether or not the company has sufficient distributable profits the directors need to provide the company’s last annual accounts. However, in addition to the company’s current financial position, the directors must also take into consideration the future position of the company i.e. that it will be able to continue trading and meet its current liabilities/debts, if the dividends are paid.

Provided that the accounts show that the company is able to pay the dividends suggested then a board meeting should be held to discuss the level of dividends to be paid out and once agreed, to formally declare the amount to be paid out. These discussions need to be properly set out in the board minutes so they can be relied upon if necessary should the dividends be challenged.

Provided the above steps are followed, then once a dividend voucher is issued by the company, which is essentially a receipt for the payment (for tax purposes), the dividend will be lawful. However, if the process is not followed correctly, then it may be the case that the dividend was paid out unlawfully.

Unlawful Dividend

As above if you have not followed the correct procedure then you run the risk of the dividend being paid illegally, which can have far reaching ramifications for the persons receiving the dividends, as well as the directors who approved payment of it. Furthermore, action can be taken against the guilty parties personally, rather than the corporate entity.

If this is the case then the individual could face the following consequences: -

A shareholder who received the dividend may be ordered to repay it to the company, if it is found that they knew or had reasonable grounds to believe that the dividend procedure was not properly followed; and

A director who authorised the payment of the dividend may also be in breach of their directors duties and could be liable to personally repay the company the value of the dividend, even if they are not a shareholder.

In addition to the above, even if the company becomes insolvent, this will not offer any protection for the guilty party (even if it is the case that the payment of the dividend did not cause the insolvency), as Insolvency Practitioners have powers under the Insolvency Act 1986 to recover the money paid out for the benefit of the creditors of the company.

In view of the above and the serious ramifications, if you get this wrong, it is essential that the proper procedure is carried out before a dividend is paid.

In short, if the company doesn’t have the sufficient distributable profits to pay a dividend, then don’t pay out a dividend. The reward is certainly not worth the risk!