What are Unlawful Dividends

Understanding unlawful dividends

Unlawful dividends happen when cash is taken out from a limited company without enough profits to support it. Shareholders who receive such dividends might need to give back the money if they know the company can’t afford to pay it out.

Alternatively, directors might have to repay not only their own but also all illegal dividends distributed by their company.

Unlawful dividends: What does it mean for company directors? 

One advantage of managing a limited company is that directors can receive most of their pay as dividends, usually a tax-efficient approach compared to getting a salary only through PAYE.

However, directors should carefully think about the timing of dividend payments, as it could make them personally liable if later found to be illegal. Before distributing any dividends, it’s crucial to ensure that the company has sufficient profits to cover them.

The regulations for issuing dividends specify that if there aren’t enough profits available to back the payment, it’s considered ‘ultra vires’, which means ‘beyond the powers’. Simply put, directors cannot authorise dividends under such circumstances.

When is the Appropriate Time for a Corporation to Pay Dividends?

The Companies Act of 2006 outlines the rules for dividend payments. Dividends can only come from distributable profits, making them illegal if there aren’t enough funds to cover them.

Directors should consult statutory accounts for the relevant period before making any distribution. However, having current interim accounts can often provide more assurance in determining the legality of the dividend.

Additional Considerations To Know Before Taking Dividends From A Company

Before a dividend payment can be lawful, several conditions must be fulfilled:

  • A board meeting should take place to discuss the amount of distributable profits accessible and officially declare the dividend.
  • The minutes of this meeting can be submitted to HMRC if there are any inquiries in the future regarding the legality of the distribution.
  • Recipients should receive a dividend voucher containing the company’s name, date, total amount payable, and the names of shareholders receiving the dividend.

Before declaring a dividend, it’s recommended to seek professional advice. Incorrectly using figures from the company’s accounts can be problematic when determining if a dividend is feasible. 

Moreover, corporation tax needs to be subtracted from the company’s profits to determine the distributable profit.

Poor administrative procedures can result in the issuance of illegal dividends, especially if current information on the company’s financial status is unclear or unreliable. It’s important to note that granting authorisation after the fact, for a dividend already distributed, is considered fraudulent.

Navigating Tax Consequences and Declarations for Dividend Income

Individuals benefit from a tax-free dividend allowance of £2,000 annually, meaning dividends below this threshold are not subject to income tax. Dividends exceeding this £2,000 limit will be taxed based on the individual’s tax band.

Tax rates for dividends are as follows: 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers, and 38.1% for additional rate taxpayers. 

Individuals earning over £10,000 in dividend income must complete a self-assessment tax return; tax on income below this can be paid by requesting HMRC to adjust their tax code.

It’s important to mention that companies do not pay corporation tax on dividend payments because it has already been deducted from the gross profit figure.

Who holds the liability for repaying an unlawful dividend?

According to the Companies Act of 2006, individuals who receive an unlawful dividend may be obligated to repay the amount. Shareholders bear responsibility if they are aware that the company couldn’t sustain the payment when it was issued.

Some shareholders might genuinely lack awareness of the company’s financial standing. In cases where there is a sizable shareholder base, it may not be feasible to recover dividend payments in this manner.

This transfers liability to the director(s) who authorised the payment. Consequently, directors may be held accountable for repaying not only their own unlawful dividends but also those distributed to other shareholders.

Understanding Unlawful Dividends For An Insolvent Company 

For directors, the risks associated with issuing unlawful dividends significantly escalate if a company becomes insolvent, regardless of whether their payment triggered the company’s financial decline. 

In situations where the company must be closed and liquidated, a licensed insolvency practitioner (IP) will be appointed to gather the company’s assets for distribution to creditors.

Part of the liquidator’s responsibility is to examine any payments made to shareholders in the years leading up to insolvency. The aim is to identify transactions that might have been unlawful, such as dividend payments.

If you’re concerned about a dividend payment that could be seen as unlawful, Vanguard Insolvency is here to assist you. Our licensed insolvency practitioners possess vast experience and can provide guidance on your risk exposure. We operate nationwide and can schedule a free same-day meeting to discuss your circumstances.

Senior Partner at Vanguard Insolvency Practitioners | Website | + posts

I am an insolvency professional with a distinguished career specialising in commercial insolvency, adeptly navigating Creditors Voluntary Liquidation, Company Voluntary Arrangements, and Company Administrations. With a comprehensive understanding of insolvency laws and an unwavering commitment to ethical practices.