Coronavirus has had a huge effect on businesses and many have been forced to review their dividend policies.
In many cases, this is due to the deterioration of the company’s financial position since the last annual accounts.
The Companies Act 2006 requires that a dividend must only be paid if there are sufficient distributable profits. In some cases, the bank account may be in credit, but the company still needs sufficient retained profits to cover the dividend at the date of the payment. “Profit” in this instance is defined as being “accumulated realised profits”.
A dividend would be classed as “ultra vires” which means “illegal” if it meets any of these criteria:
- The dividend is proven to be more than the sufficient retained profit amount
- The dividend is made out of capital
- The dividend is paid when there are losses that exceed the accumulated profits then this.
If you have a private company, there is no need for full accounts to be prepared to prove sufficient profits in the calculation for an interim dividend. However, you must provide the calculation in the accounts for the declaration of a final dividend.
HMRC’s Corporation Tax Manual states that the accounts need to be detailed enough to enable “a reasonable judgement to be made as to the amount of distributable profits” as at the payment date.
Before any dividend payment is made, the financial status of the company must be considered. The test must be satisfied “immediately before the dividend is declared” and this is generally interpreted to mean that the “net assets” test must be satisfied immediately before any company directors decide to pay the dividend.
A lawful dividend is when the directors correctly prepare basic interim accounts and a dividend is paid based on those accounts. This is the case even if the final annual accounts that are prepared at a later date show that there was an insufficient amount for distributable profits.
If your business withdraws regular amounts via dividend and the management accounts show a trading loss or the profit cannot support the payment, these amounts would be deemed as “illegal”. HMRC would argue that “in the majority of such cases” the director/shareholder of close companies will be aware that this dividend payment was illegal.
What are the consequences?
The main consequence of paying “illegal” dividends could arise if the company goes into liquidation. When a business goes into liquidation, a liquidator or an administrator will review the director’s conduct over the three years before liquidation.
If the director is found to have paid a dividend “illegally”, then the shareholders will be expected to repay the amount unlawfully withdrawn under the Companies Act 2006.
HMRC are often the largest unsecured creditor of many businesses in liquidation so they will actively pursue the route of conduct. The Insolvency Act states that, as a director, you can be held personally liable for any breach of fiduciary duty to the company.
Even if you are not liquidating your business, HMRC could open an enquiry at any time into the treatment of a dividend.
HMRC treats a dividend that it perceives to be illegal as being the equivalent of a loan and, for a “close” company, this means being a loan to a participator and must be declared on the company tax return and could be subject to Section 455 tax.
If a loan isn’t declared, and the financial statements filed with Companies House show that the company’s reserves are in a deficit at the end of the relevant period, HMRC may investigate. Similarly, where the opening balance next year is in a deficit but dividend payments are still paid out.
In some cases, HMRC has been known to argue that the repayable amount is an interest-free loan. For a director employee, this could result in a taxable benefit-in-kind should the loan be less than £10,000.
Therefore, please make sure you are paying dividends correctly to avoid any problems at a later date.
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