Mark McLaughlin warns in the context of family or owner-managed companies that ‘backdating’ dividends can have serious repercussions.
It is common in family or owner-managed companies for dividends to be paid to their shareholders. In most cases, the company’s constitutional documents provide for its shareholders to declare dividends in general meetings, although sometimes the directors are given the power to declare dividends to the exclusion of general meetings.
Don’t pretend!
Dividends must comply with certain legal requirements to be lawful. A serious mistake for company owners is ‘backdating’ dividends (e.g., pretending a dividend was declared earlier than it was really declared by dating the dividend paperwork prior to the date of the decision to declare it). Such dishonesty could land those responsible in serious trouble with the law!
Dividends are often credited to directors’ loan accounts (DLAs) with the company, such as to repay or reduce an overdrawn loan account. However, care is needed. It may not become clear that dividends are desirable for an accounting period until much later, when the company’s accounts have been prepared for that period.
Which date?
For example, in Manolete Partners Plc v Rutter & Anor [2022] EWHC 2552 (Ch) (a non-tax case, although HM Revenue and Customs presented a winding-up petition for unpaid corporation tax), the defendants (Mr and Mrs R) were the directors and shareholders of a company (Rut5). The company entered administration in November 2017 and went into creditors’ voluntary liquidation from November 2019.
Due to significant withdrawals from their DLA, by July 2015 Mr and Mrs R owed Rut5 £688,833. In July 2016, the company’s accountant (Mr L) prepared and discussed draft accounts to 31 July 2015 with Mr and Mrs R, who decided: (i) to take an interim dividend of £560,000; and (ii) to offset that £560,000 against their DLA. Mr L then prepared the final accounts on that basis, backdating the transaction to 31 July 2015, which Mrs R formally approved in July 2016. However, Mr L did not complete the Sage accounting system entry recording a ‘net dividend’ of £560,000 (reducing the overdrawn DLA balance to £128,833) until April 2017.
The Sage accounting entry showing the net dividend of £560,000 was dated 31 July 2015 but was sandwiched between two entries dated April 2017. Subsequently, a dispute arose over when the dividend of £560,000 reducing Mr and Mrs R’s DLA amounted to a ‘distribution’ (i.e., July 2015, July 2016 or April 2017). The timing largely determined whether the dividend was unlawful; if made in April 2017, it was unlawful because the company was insolvent by then, whereas if made in July 2015 or July 2016, it was lawful (or at least was not unlawful due to the company’s later insolvency). The court concluded that the dividend was in July 2016, when positive action was taken to declare a dividend of £560,000, to allocate it to reduce the DLA, and record it in the 2015 accounts (notwithstanding that Mr L did not input it onto Sage until April 2017).
Practical tip
Aside from the non-tax law aspects, remember that dividends need to be properly recorded on the individual shareholder’s self-assessment return for the correct tax year (i.e., normally, the tax year the dividend becomes due and payable).
