Are Your Company’s Dividends Valid?

Many family or owner-managed businesses (OMBs) will pay dividends several times a year. It is important to get the process correct, lest they be challenged by HMRC later on. This article will focus on the tax aspects of dividends but it should be borne in mind that HMRC may not be the only interested party; insolvency practitioners commonly scrutinise a company’s dividend history on behalf of creditors, to see if dividends should be repaid. The following guidance is aimed at small family companies; the rules for public companies are different.

A dividend may be challenged where it is found to have been made otherwise than in accordance with the Companies Act 2006 or the company’s own legal constitution – broadly, its Memorandum and Articles of Association. 

Who authorises dividends?

It is generally the company’s own Articles of Association that determine who may authorise dividends. While a company may devise its own Articles with specific provisions, they will by default follow a standard template, which usually prescribes in the manner as set out below.

For these purposes, there are two types of dividend:

Of course, in an OMB company, the directors and shareholders will normally be the same individuals. But it is important to recognise the different capacity/ies in which the individuals are acting, when documenting the process. 

Dividends may only be paid when the company has the funds to do so – not necessarily money in a bank account, but profits. The Companies Act 2006 specifies that a dividend or distribution to shareholders may be made only out of profits available for that purpose (CA 2006, s 830).

Simply put, those are the accumulated realised profits since the company’s inception, less accumulated realised losses to date, less amounts already distributed (e.g. paid out as dividends) or capitalised. 

Joe’s Suds Limited has been trading for several years. Over the company’s lifetime, it has generated profits after tax of £560,000, made losses of £50,000, and paid out dividends of £400,000. 

The company has distributable profits of £560,000 - £50,000 - £400,000 = £110,000. 

The company can pay some, all or none of that £110,000 out as a dividend – the profits or losses made in the latest period are not important, except inasmuch as they affect the total cumulative figure for distributable profits. Of course, if several dividends are paid out in one year, regard must be had to the dividends already paid in that year, when calculating the remaining profits available for distribution. 

In practice, it would be very difficult to establish exactly what a company’s distributable profits were at the point of making every dividend payment, so the Companies Act says reference should be made to the ‘relevant accounts’.

In order to check what profits are available for distribution in the period, the directors/shareholders must refer to the relevant accounts. These are usually the latest annual accounts laid before the company in a general meeting. 

However:

Despite the aim of ensuring that a company’s dividends should not be so large as to prevent it from being able to pay off its liabilities, it is possible that the latest accounts will indicate a level of distributable profits that proves to be too high – the dividends can turn out to be excessive. This will not necessarily make the dividends ‘illegal’:

The facts are as in Example 1. The directors of Joe’s Suds Limited vote to pay an interim dividend of £80,000, leaving cumulative distributable profits of £30,000, based on the latest previous annual accounts. 

Unfortunately, the company then has a disastrous period, and the next set of annual accounts show a loss of £50,000; far from having spare distributable profits of £30,000, the company has negative reserves (i.e. -£20,000) at the end of the year. The dividends are not illegal, because they were in order, at the time they were paid. 

See HMRC’s Company Taxation manual at CTM15205 (under ‘The Relevant Accounts’) for confirmation of this; however, this does not absolve a director of his general duty of care to safeguard assets and to ensure a company is able to pay its debts as they fall due, and if a director is already aware of a company’s current losses or similar relevant event at the time of considering a dividend, he should take them into account. 

It is essential that the paperwork be drawn up correctly to support the dividend. 

For final dividends, general meetings are no longer necessary per se, provided a majority of shareholders approve the proposed dividend by ordinary resolution – and provided the company’s Articles are not more prescriptive than in the Companies Act 2006 (generally, more recent Articles by default require only a resolution, but older Articles are often more demanding). 

The documentation should evidence that the relevant accounts have been considered, and the distribution approved. A final dividend is deemed to be an enforceable debt when fixed as payable by resolution of the shareholders (the resolution may specify a future date for payment). Since a shareholder can enforce the debt once payable, it is deemed to have been paid at that time. 

An interim dividend may be varied at any time before it is actually paid, and as such is deemed to be paid only when the funds are placed unreservedly at the disposal of the shareholder. This is straightforward when dealing with a money transfer, but if effected by journal entry in the company’s books of account – typically by way of a credit to a director’s loan account or similar – then an interim dividend will be deemed to have been paid only when the relevant entries have been made. HMRC is well aware of the potential for problems when this turns out to be by the company’s accountants when the audit is done several months later! See HMRC’s guidance in the Savings and Investment manual (at SAIM5040) and Company Taxation manual (at CTM15205). 

Dividends should be paid in proportion to respective shareholdings. It is possible for a shareholder to waive some or all of his entitlement to a dividend, but it should be waived before entitlement to the dividend arises. To be legally effective, a deed of waiver needs to be signed, dated, witnessed and lodged with the company.

Dividend vouchers are still required, despite there no longer being a ‘tax credit’ in the new dividend regime introduced from 6 April 2016 (increased rates of dividend taxation, abolition of notional tax credit, etc). Finance Act 2016 (Sch 1, paras 39-42) updated the legislation at CTA 2010, ss 1100–1106) to remove reference to tax credits, but s 1104 still imposes a requirement (for OMB companies) to furnish the taxpayer with a ‘tax certificate’ confirming that a dividend has been paid, within a reasonable period.

Dividends are still a key tool for tax efficient income planning in OMBs. But getting the procedure and paperwork right is essential, including: