Many owner-managed companies use dividends as a means to extract cash from the business. The practice of paying dividends has been attracting more and more attention from HMRC. Getting it wrong can have expensive tax consequences – so what is the right way to do it?
Paying dividends – company law
The s830 Companies Act 2006 states that a company is only entitled to make distributions out of profits available for the purpose. It defines these profits as ‘accumulated realised profits minus accumulated realised losses’. It is also stated that a dividend must be supported by relevant accounts which demonstrate that profits are indeed available for distribution.
For paying a year-end dividend, the statutory accounts will most likely be the appropriate accounts.
In respect of paying interim dividends, directors may be called upon to make what the law calls ‘reasonable judgment’ of the company’s current financial position and its ability to meet debts as they fall due.
Directors should take their responsibilities in regard to paying dividends very seriously. In the event that shareholders receive a dividend whilst knowing that there were not sufficient reserves available at that time, they can become liable to pay it back. Company directors may also become personally liable.
To ensure that dividends are paid lawfully, always follow correct procedure. Good practice would be to hold a directors’ meeting to consider the accounts and declare the dividend. Ensure the meeting is minuted and that a dividend voucher is prepared at this time.
It is not unheard of for individuals and companies to lose a tax tribunal for neglecting points such as these.
In one case, a tribunal heard that ‘there had not been any directors’ meetings at, or resolutions in which, any of these amounts had been declared as dividends’. The tribunal subsequently found that the amounts were not, in fact, dividends but earnings. HMRC were entitled to recover PAYE income tax and National Insurance from the directors personally.
HMRC are becoming more vigilant and paying particular attention where insolvencies are involved.
For information of users: This material is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material can be accepted by the authors or the firm.