A common way for directors to be remunerated from small limited companies is to take a combination of salary and dividends. However, there are ramifications if the company gets into trouble.
In the case of an insolvency, liquidators and administrators will seek to recover all assets for the benefit of the creditors. The issue of unlawful dividends arises in cases where small business owners take remuneration by way of dividends rather than salary, specifically more dividend than they are entitled to. Where an Insolvency Practitioner identifies that a dividend is unlawful he will ask the shareholder to repay it or an equivalent value (if the distribution was of a non-cash asset).
Directors and shareholders should be aware that specific steps and criteria must be met and complied with before declaration and payment of dividends. Failure to comply with the complex provisions of the Companies Act 2006, the company’s own articles of association and a director’s general duty of care can result in dividends being declared unlawful. The key points to bear in mind are as follows:
- Ensure that the Company has sufficient retained reserves (aka available profits) to pay a dividend. If directors rely on the company’s most recent annual accounts, they must demonstrate that they have taken due consideration of post balance sheet events to be able to declare a dividend.
- Interim accounts should be sufficient for directors to make a reasonable judgement on a proposed dividend and should include profits, losses, assets, liabilities, provisions, share capital and reserves.
- In considering a distribution, directors must be mindful of their fiduciary duty to safeguard the company’s assets and be in a position to demonstrate that they have exercised reasonable care, skill and diligence in ensuring that the company is able to settle its debts as and when they fall due.
- Hold a meeting of the members to authorise the declaration of a dividend and its payment, ensuring that the meeting correctly recorded.
These key points are touched on here.
The consequences of unlawful dividends are considerable for directors and shareholders. Shareholders may be asked to repay dividends, and could find that HMRC will re-categorise the income as salary (which will be subject to extra income tax and NIC). Directors could find themselves in breach of their duties and therefore held to be personally liable.
In difficult or challenging trading circumstances, directors should look very carefully at whether they should continue to withdraw funds from a company by dividend. Reasonable remuneration paid through the PAYE system is unlikely to be queried by an Insolvency Practitioner – although if the company isn’t trading profitably, then it is unlikely that money will be available to draw as either salary or dividend.
As accountants, we advocate the responsible administration of dividends and look to help our clients in achieving this. If you need any help, please contact us.