The danger to shareholders (and accountants) of unlawful dividends
March 14th, 2018
Why would you be doing that?, I hear you ask. The reason is that occasionally company directors approve and pay dividends when it is illegal to do so. If and when that company goes into liquidation, and I discover that illegal dividends were paid, HMRC will come down like a ton of bricks – not just on the hapless shareholders but also, potentially, on the company’s accountants.
The effect of illegally-paid dividend payments as regards an insolvent company can be traced back to the point of insolvency – which can be a number of years back in time in extreme cases, so when a business goes bump it is not just the last set of accounts that are of interest to the insolvency practitioner.
Look, dividends are a great idea and a tax-efficient method of getting money back to the shareholders. But you cannot mess with them. They are completely unrelated to wages, bonuses, expenses or any other form of remuneration. They can only be paid under specific conditions and those conditions are clearly laid out in the Companies Act 2006 (“CA2006”).
Dividends have to be formally declared at a board meeting and there has to be a minute of that meeting which relates specifically to the dividend. Ideally, that minute will explain that the directors have assessed the company’s financial position and concluded that there are sufficient profits available for distribution to allow for a dividend to be paid. Even if the business is a two-person, husband-and-wife affair, the meeting still has to be held and minuted in this way. Paperwork can be a pain, but in this case it is essential!
The Companies Act is also clear as to what “profits available for distribution” means:
(1) A company may only make a distribution out of profits available for the purpose.
(2) A company’s profits available for distribution are effectively the cash available after deducting previous dividends, capital movements and accumulated losses. (It’s a bit more complicated than that as set out in CA2006 but I can advise on the exact amount it should be.)
Having said that, just because there is money in the company’s bank account does not mean that there are profits available for distribution. If directors award ‘dividends’ which can be shown to have contributed to a deteriorating cash-flow position and insolvency of the company they can potentially also be open to disqualification as a director.
But illegal dividends are not just illegal as a result of discovery during insolvency proceedings. They are illegal – period. Shareholders who receive them will have to pay them back to the Liquidator in insolvency proceedings. Additionally, if they do not, HMRC may class them as salary (and so the recipients would be liable for additional income tax and NI deductions).
To underline the importance of declaring dividends formally, assessing available profits properly, and minuting them correctly, ICAS (the Institute of Chartered Accounts) has issued an ‘advice note’ from Philip McNeill, its Head of Taxation (Tax Practice and Owner Managed Business Taxes). His article relates to ‘Close company clients’ – limited companies with five or fewer ‘participators’ (basically shareholders), or a limited company of which all the ‘participators’ are also directors. This type of company is also my typical insolvency client!
In it, Mr McNeill notes that: ”Should insolvency be in the wind, HMRC is likely to take a very serious view indeed, with directors becoming personally liable to repay the supposed dividend to the company.
If the company is solvent, the sum may still require repayment, which may leave an outstanding balance on a director’s loan account… triggering a tax charge under s455 CTA 2010”.
However, his parting shot is aimed at accountancy firms and advisers who, more often than not, are involved in dividend planning for their clients and who are, of course, subject to their profession’s codes of ethics and professional conduct.
“HMRC can impose Dishonest Agent penalties where it considers an agent has been dishonest with a view to bringing about a loss of tax revenue”, he points out.
Both advisors and directors/shareholders must be aware of this little nugget – over the years I have successfully pursued the repayment of illegal dividends – the biggest one in recent years was in excess of £173,000! Rather than ending up in a position of having to repay, call me if you have any doubts and we can assess how to mitigate the position before it becomes a problem.