Many businesses have struggled with rising costs recently, impacting their profitability, Consequently illegal dividends have become a more frequent issue for limited company owners.
What are illegal dividends?
When dividends are paid to shareholders they are typically from current year profits. According to the Companies Act 2006 dividends can only be paid from distributable profits. These include current and retained profits from previous years. When a company pays dividends without sufficient profits, these are known as illegal dividends.
Legal consequences
The Companies Act states that dividends should only be paid from distributable profits. Therefore, directors authorising illegal dividends face serious ramifications. Additionally, this can include a personal liability to repay those dividends. This repayment obligation extends to shareholders who knew or suspected those dividends were illegal.
Tax issues
Historically HMRC argued that unlawful dividends were salary payments because this resulted in a greater tax liability. However, HMRC is now, more willing to treat these as director's loans. If HMRC proves difficult, direct them to their internal guidance to refute their approach.
The solution
Once you determine the total unlawful dividends, they must be attributed to each shareholder proportionally and recorded as a loan in the company's records. Shareholders must repay the loans, though there is no specified deadline for repayment.
Company's tax position
If the loan is not repaid within nine months after the company's accounting period ends, the company faces a corporation tax charge of 33.75% on the outstanding amount. So for example for the year ended 31 March 2024, loans must be repaid by 31 December 2024.
Individual's tax position
If the shareholder owes the company more than £10,000, including any other amounts owed, a taxable benefit in kind applies. Given the current interest rate of 2.25%, the tax charge may be relatively modest.
Possible waivers
It is possible to waive the outstanding loan to avoid any illegal dividends, but be mindful of the tax consequences.
Prevention is better than cure
To avoid the chance of illegal dividends, use an online system and work with the right adviser. This ensures access to real time financial information, potentially avoding this issue.
For more useful information, check out our Ebooks here.
And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at [email protected].
Alternatively, please feel free to complete our Business Questionnaire here.