Why Company Dividends Must Be Handled Carefully

Paying dividends is a common way for company owners to take money from their business. However, many directors do not realise that company law has strict rules around how dividends must be paid.

If those rules are not followed correctly, the dividend may be considered unlawful. In some cases, shareholders can even be forced to repay the money.

There can also be tax consequences. HMRC may decide that payments labelled as dividends were actually salary payments instead. This could result in additional PAYE tax and National Insurance liabilities.

Dividends Can Only Be Paid From Profits

A company can only pay dividends if it has enough distributable profits available.

Before declaring a dividend, directors should review the company’s accounts to confirm that sufficient profits exist. These may be:

• the latest annual accounts;

• more recent interim accounts; or

• initial accounts for a newly formed company.

Directors should also consider:

• whether the company has enough cash to pay the dividend;

• the overall financial position of the business; and

• whether the company will still be able to pay its debts and ongoing expenses afterward.

A Real Court Case Example

A well-known case involving Dirk Hale highlighted the risks of getting dividends wrong.

Mr Hale was a director and shareholder of a company called Powerstation UK Limited. Like many owner-managed businesses, he took a small salary and additional payments labelled as dividends.

The company’s accountant planned to review profits at the end of the year. If there were not enough profits available, the payments would be reclassified as salary instead.

However, the company later went into liquidation. The liquidators discovered that there had not been enough distributable profits to support the dividends that had been paid.

As a result, the dividends were considered unlawful.

What the Court Decided

The case eventually reached the Court of Appeal.

The court ruled that:

• the payments were intended to be dividends from the start;

• changing the classification later did not make them valid; and

• there was no proper agreement in place to treat the payments as salary or additional remuneration.

This meant the dividends had been paid unlawfully.

Why Proper Documentation Matters

Dividend paperwork is extremely important.

Companies should always prepare:

• board meeting minutes;

• dividend vouchers; and

• shareholder approvals where required.

Interim dividends should also be formally documented.

It is also important to remember that dividend paperwork cannot be backdated. Attempting to create documents after the event can create serious legal and tax problems.

Accounting Rules Are Important Too

Under accounting standards, a dividend cannot be recognised in the financial statements unless it has been properly declared by the reporting date.

Simply expecting to pay a dividend is not enough. There must be a legal obligation supported by proper documentation.

Without this, the dividend may not be valid from both a legal and accounting perspective.

Key Takeaway

Dividends should never be treated casually.

Before paying dividends, directors should make sure:

• sufficient profits are available;

• the company remains financially stable afterward; and

• all documentation is prepared correctly and on time.

Failing to follow the correct process can lead to:

• unlawful dividends;

• additional tax liabilities; and

• demands for repayment if the company later faces financial difficulties.