When you invest in a company, you’re taking a chance that the directors will use the funds to generate profit. In return, shareholders usually receive a share of the company’s success through dividends. But what happens if the company makes a loss? Can a dividend still be paid? Let’s dive into the rules and the alternatives.
When Can a Dividend Be Paid?
A company can only pay a dividend if it has enough distributable profits on the date of payment. These profits are the accumulated, realised profits—essentially, profits from the current or previous periods, after covering any losses.
If a company doesn’t have enough distributable profits and a dividend is paid from capital, it’s classified as an illegal dividend under the Companies Act 2006.
How Do You Know If a Dividend Is Legal?
A dividend’s legality might only become clear when the final accounts for that period are prepared. That’s when you’ll know if the company had enough distributable profits to support the dividend at the time it was paid.
While there’s a statutory requirement to have full accounts to back up the payment of a final dividend, no such requirement exists for interim dividends. However, it’s always wise to prepare management accounts before declaring any dividend. This helps ensure that sufficient distributable profits are available.
What Happens If a Dividend Is Paid Illegally?
If HMRC determines that a dividend was paid unlawfully, they will treat it as if the shareholder never received it. The shareholder may be required to repay the dividend. HMRC can recover illegal dividends up to six years from the declaration date or payment date, whichever is later.
The only scenario where the shareholder may not need to repay is if they had no knowledge of the dividend’s illegality and no reason to suspect it. However, in owner-managed companies where directors are also shareholders, proving a lack of knowledge can be tricky.
If the shareholder can’t repay the illegal dividend, HMRC might reclassify the payment as a loan. If this loan isn’t repaid or written off within nine months and one day after the year-end, the company could face a tax charge. The tax rate for this charge is 33.75%, in line with the higher dividend tax rate.
Additionally, if the total of all loans from the company exceeds £10,000 at any point during the tax year, the director could face a benefit-in-kind charge unless interest is paid on the loan.
What Are the Alternatives to Dividends?
If the company can’t pay a dividend due to a lack of distributable profits, there are a few alternative options:
- Salary or Bonus: The company could pay a salary or bonus instead of a dividend, but this comes with additional tax and National Insurance costs.
- Benefits in Kind: If payment is made partly in cash and partly in goods or services, this may count as a taxable benefit in kind, which could be taxed at a lower rate than 33.75%.
- Repaying Share Capital: A company can repay share capital or share premium by crediting the profit and loss account. This can create positive reserves on the balance sheet, allowing a dividend to be paid.
If any illegal dividends are discovered, the company must add a note to the year-end accounts, and the directors should stop paying dividends until the company has accumulated distributable reserves.
Need Help Navigating Dividends and Distributable Profits?
Paying dividends from your company can be a complex process, especially when dealing with losses. If you’re unsure about the rules or need advice on alternatives, get in touch with Jon and the team today. We’ll help you ensure your payments are legal and tax efficient.
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