Do You Have to Take a Dividend? Reasons Why Not To

Many directors believe they have an absolute right to the funds in their company’s bank accounts. However, withdrawing money as a dividend isn’t that straightforward. There are strict procedures to follow to ensure legal compliance.

Understanding ‘Illegal’ Dividends

A dividend is a distribution of post-tax profits, and it can only be paid if the company has sufficient retained profits. Before declaring a dividend, it’s essential to verify this. Paying a dividend without adequate profit means the company is effectively insolvent and breaking company law. Even if the bank account is in credit, that doesn’t necessarily mean there are enough profits to cover the payment. It’s the retained profits that matter.

For instance, a dividend could be paid during a loss-making period if there are sufficient retained profits brought forward to cover it. Conversely, even if a profit is made during an accounting period, a dividend can’t be paid if retained losses mean an overall loss.

Preferences and Tax Advantages

There are situations where a shareholder might prefer not to receive a dividend, or where it might be tax-advantageous for them not to do so. This is common when some shareholders are higher-rate taxpayers while others are basic-rate taxpayers or non-taxpayers.

For example, a shareholder might not want a dividend if they are claiming Child Tax Credit, as the additional income could push them over the limit. Similarly, taking a dividend might trigger the High-Income Child Benefit charge. In these cases, shareholders might consider waiving their dividend.

All shareholders with the same class of shares receive dividends proportionally. Without ‘alphabet’ shares—different classes of shares that allow for varied dividend rates—shareholders might need to waive (or defer) their dividend. Waiving means voluntarily giving up the right to receive a dividend, allowing the other shareholders to receive their share. The waived amount stays in the company’s bank account.

HMRC’s Stance

When a shareholder waives their dividend, the remaining funds stay within the company, potentially benefiting the other shareholders. However, HMRC may scrutinise this practice. They might argue that the waiver indirectly provides funds for an ‘arrangement’ or ‘settlement’—essentially a scheme to avoid tax.

The ‘settlement’ rules are anti-avoidance provisions. They apply when the settlor (the person waiving the dividend) retains an interest in the waived amount, and either they or their spouse benefits from it. If HMRC deems the waiver a settlement, the dividend remains with the original shareholder for tax purposes.

Practical Points

Navigating the complexities of dividends requires careful planning and understanding of the tax implications. If you’re unsure whether taking a dividend is the best option for you or your shareholders, it’s wise to seek professional advice.

For tailored guidance on dividend strategies and tax implications, contact Jon Davies Accountants today. Our expert team is here to help you make informed decisions and optimise your financial outcomes.

 

 

 
 
 
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