When a director/shareholder takes a dividend from the company which has insufficient profit (including leftover profits of previous years) it is known as an “illegal” dividend. Taking dividends from your own company is a legal process. If your accountant says ‘just transfer the money into your personal account’, be careful. Without following proper procedure, your dividend could be classed as “illegal” or “unlawful” by the taxman.
This article is relevant to you if you are:
- Owner of a Limited company
- Shareholder of a family Limited company
- Take regular dividend
In short, your business is an “owner-managed business” known as “Close Company” in legal terms (ref CTA 2010, Part 10 s439). Many business owners think that it is the responsibility of their accountant to look-after legal matters but sadly, in the eyes of the law, you are responsible for all legal and tax compliance as a director of the company.
HM Revenue & Customs and Companies House are the two Government department monitor every Limited Company business.
Every Limited company needs to report to Companies House for legal compliance relating to the company, director, shares, shareholders, addresses, and its legal structure as per “Companies Act 2006”. Generally Chartered Qualified Accountant is competent to deal with majority compliance for a small owner-managed limited company.
As a director, you are aware about Companies House Confirmation Statement and Annual Accounts which are submitted every year. There are many compliance-related activities that are not automatically covered in the Accountancy fee. This is the main issue when dealing with dividend related compliance. Many unqualified accountants mislead their clients about “dividend”.
HM Revenues & Customs – HMRC
Every year your Accountant submits Full Accounts with Corporation Tax Return (known as CT600), full and detailed Accounts. HMRC has the authority to inspect the records and compliance papers of your company. A dividend is an area which is very much ignored by owner-managed businesses.
Formalities for Dividend:
The Dividend is paid out of the “Reserves” of the company. The reserves are the money a company has left over after paying all its business expenses and liabilities, including all taxes due. Before a company can legally pay a dividend, it must have sufficient distributable profits. The law regarding distributions is governed by Part 23 of the Companies Act 2006.
Types of Dividends
Dividends can either be final or interim:
2.1 Final Dividends
A final dividend is paid once a year, calculated after a company’s annual accounts have been drawn up so the company will know what its financial performance is and therefore what, if any, dividends can be declared. How dividends are recommended and declared is set out in a company’s articles of association. The Companies Act 2006 does not specify who shall declare dividends and does not require dividends to be declared by shareholders at the general meetings.
2.2 Interim Dividends
Interim dividends can be paid at any time throughout the year and are calculated before the company’s annual accounts are drawn up, meaning before the company’s financial performance is determined. An interim dividend is usually decided solely by the board of directors (recommended and declared) and distributed either quarterly or after six months. There are no rules which determine how often dividends are distributed, however from a practical processing point of view, quarterly or every six months is considered easier for record-keeping.
Board Meeting and Shareholders’ Ordinary Resolution
What type of board meeting is required by an SME private company will depend on what type of dividend is being declared (interim or final) and whether the articles of the company enable the directors to both recommend and declare the dividend or require the declaration to be made by the shareholders.
Board minutes must be kept as part of company’s general records and in case they are required by HMRC as evidence that a dividend was properly recommended and declared.
Each shareholder must be sent a dividend voucher by the company. A dividend voucher is a written record stating who has received the dividend, how much it was and what shares the dividend receiver owns. It is like a formal receipt and provides a record of the dividend. Sometimes a dividend voucher will be sent to a bank or building society if the dividend is to be paid into a bank or building society account.
The rationale behind a dividend voucher is that shareholders must pay tax on any dividends they receive from UK companies each tax year via the self-assessment process.
The voucher should state:
- Company name
- Name and address of the shareholder
- Total shareholding
- Amount of dividend being paid
- Date of the payment
- Company director’s signature
Poor administrative processes can also lead to the payment of illegal dividends – if up-to-date information on the company’s financial situation is sketchy or unreliable, for example. It is also worth noting that providing authorisation in hindsight, for a dividend that’s already been issued, is regarded as fraudulent.
An illegal dividend is not a criminal offence, but it has tax implications. The HMRC will treat a dividend as payment to shareholder/director and relevant tax and National Insurance will be liable by the limited company and by the director. If you have closed the company and put it into liquidation, you will have to pay it back with interest and tax.
For more assistance on this matter contact Sterling Finance and we will be able to help. Our contact details are: