Practical issues relating to dividend distributions

A dividend is a payment made by the company to its shareholders, usually as a distribution of profits. Part 23 The Companies Act 2006 (section 829 to 853) details all the provisions for distributions made by the company. A dividend or distribution to shareholders may only be made out of profits available for the distribution.

What is an illegal dividend?

If the requirements of the Companies Act are not met, a dividend is unlawful (section 836(4) of CA 2006). Furthermore a dividend may be deemed illegal if:

• it is not authorised correctly through board minutes. Prior to the meeting, directors have to assess whether the company has enough distributable reserves to declare any dividend to the shareholders. HMRC requires keeping these minutes for the justification of the dividend declared
• a dividend voucher has not been completed: this is a ‘receipt’ for tax purposes. It should show the dividend rate per share, dividend figure, and the amount of tax credit if there is any.

Illegal dividend is also termed as ‘ultra vires’. Dividends deemed illegal by HMRC may be classified as salary, on which national insurance and tax becomes due.

Directors who are normally also shareholders in a small company need to be careful if they are taking regular dividends out of the company. They need to make sure that they have last annual accounts or interim accounts which support the distribution.

Read the In Practice article, 'Avoiding the pitfalls of unlawful dividends'.

What are ‘profits available for distribution’?

A company’s ‘profits available for distribution’ are its accumulated, realised profits, so long as it is not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so long as it’s not previously written off in a reduction or reorganisation of capital duly made (s847 of CA2006).

Further restrictions are placed on public limited companies.

What is the shareholders’ liability if the dividend declared is ‘illegal’?

A shareholder is only required to repay an unlawful distribution if they know or have reasonable grounds for knowing that it was made unlawfully at the time of the payment.

What are disclosure requirements for illegal dividend?

In the accounts of private companies, the directors may include within the dividend note either:

• an explanation that the dividend was not illegal as it was based on interim accounts which showed there were sufficient profits available for distribution at the time the dividend was paid, or

• an explanation of the illegal dividend payment and reasons why the event occurred. For example: ‘The directors acknowledge illegal dividends were declared and paid. No further distributions have been made and the directors are seeking to recover monies from the shareholders’.
  
  Another example is ‘At the time the dividend was paid the directors were not aware that there were insufficient profits available for distribution and the directors acknowledge that no further distributions can be made until there are sufficient profits available for that purpose’.

The note should explain the situation to readers of the accounts and therefore should be appropriately tailored to fit the circumstances.

If the accounts are audited and there is a material uncertainty or disagreement of disclosure the auditor will need to consider the impact on the audit report.

In the accounts of public limited companies there are additional requirements both in relation to the accounts and the auditors.

When is a dividend paid or deemed to be paid?

For Corporation Tax Act, CTA10/S1168 (1) says ‘for the purposes of the Corporation Tax Acts dividends shall be treated as paid on the date when they become due and payable’.

Companies’ articles often provide that:

• interim dividends may be paid by directors from time to time; and
• final dividends may be declared by the company in general meeting.

An interim dividend may be varied or rescinded at any time before payment and may therefore only be regarded as ‘due and payable’ when it is actually paid (see Potel v CIR (1971)).

A properly declared final dividend is an immediately enforceable debt unless a payment date is specified.

Can a dividend be backdated?

No, the dividend obligation is only created on the date of declaration. Therefore, any dividend declared after the year end for previous year accounts would only be deemed to be paid in the year of declaration. It will be fraudulent to back-date any dividend.

Does a dividend waiver need to be disclosed in the financial statements?

Under UK GAAP FRS 102, dividend disclosure is an encouraged note in Appendix E of section 1A for small entities. Encouraged notes may nevertheless be necessary in order to give a true and fair view and meet the requirements of section 393 of CA 2006.

A dividend waiver should typically be used only for genuine commercial reasons, and not purely to avoid tax. A long-term waiver could be deemed to be a transfer of value for inheritance tax purposes (s98 of IHTA 1984) and even ‘value-shifting’ for capital gains tax purposes (s269 of TCGA 1992). When planning dividend waivers, settlements legislation must be considered (s619-620 of ITTOIA 2005).

One can argue that generally a dividend waiver transaction has not been concluded under normal market conditions; hence a disclosure would be required irrespective of the amount involved under related party note.

Can a shareholder force the company to pay a dividend?

No, a shareholder cannot insist on the company declaring a dividend. Directors can declare and pay a dividend or propose a dividend to be approved by the shareholders in general meeting.

The shareholders in general meeting may confirm a dividend already paid out or declare a dividend to be paid out, the directors having set the amount. The Articles may put in place additional restrictions in addition to those in the Companies Acts.

ACCA's factsheet, ‘Dividend in specie and distribution in specie in private company’ , provides a broad overview of company law, reporting, accounting treatment and tax issues in relation to dividends and distributions in specie.

Further resources

Template: dividend vouchers, minutes and waivers

Legislation: Companies Act 2006, Part 23 ‘Distributions’

HMRC manual CTM15205