Unlawful Dividends

Dividends often serve as an indicator of a company’s health and growth potential. However, they can become a double-edged sword if not handled with precision and care. Understanding what constitutes an ‘unlawful dividend’ and the repercussions thereof is essential for every director.

In this blog, we will aim to give you an understanding of what they are, how to avoid them, and what the repercussions are for directors who fall foul of them.

Unlawful Dividends: What are they?

Unlawful dividends arise when dividends are declared without sufficient profits within the company to cover them. The Companies Act, 2006, clearly states: “a dividend or distribution to shareholders may only be made out of profits available for the purpose.” Simply put, you can’t distribute what you don’t have.

But it’s not just about profit availability. A dividend could also be termed illegal if:

• Proper authorisation isn’t provided. This involves maintaining minutes from board meetings sanctioning the release of dividends. These minutes validate the directors’ assessment of available profits before granting approval. This remains essential even for sole directors to meet HMRC standards.
• A dividend voucher hasn’t been filled out. This ‘receipt’ is vital for tax documentation, displaying details like the dividend rate per share, the dividend amount, and the tax credit associated.

Such illegal dividends may be termed as ‘ultra vires’ (beyond the powers), suggesting that directors, in essence, don’t have the real authority to approve these payments from company resources.

How Do Illegal Dividends Arise?

Several scenarios can lead to the inadvertent issue of illegal dividends:

• Miscalculations: Utilising incorrect profit figures can culminate in wrongful dividend disbursements.
• Negligence in Documentation: The absence of board meeting minutes or dividend vouchers, as mandated, can result in unlawful dividends.
• Manipulation of Records: Fraudulently backdating authorisation for already issued dividends is not just illegal but can attract penalties and fines.
• Poor Record-Keeping: This can inadvertently pave the way for unlawful dividends, both from an administrative and financial standpoint.

It’s worth noting that claiming unawareness or ignorance of the rules isn’t a get-out-of-jail-free card. Directors can still be held personally liable.

Establishing Profit Foundations for Dividends

Basing dividends on up-to-date and accurate profit figures is paramount. Using older year-end accounts can be misleading. Whether through real-time online management accounts or interim accounts, directors need to ensure they’re working with current data. These accounts should clearly highlight profits, considering all liabilities, essentially, “accumulated realised profits less accumulated realised losses.”

While an accountant’s expertise can be invaluable in preparing or verifying these figures, remember, the ultimate responsibility rests with the director.

Unlawful Dividends In Insolvency

Unlawful dividends, when combined with impending insolvency, can place directors under severe scrutiny.

Sometimes, a rosy picture painted by cash flow and current profits can mask underlying issues. Unforeseen future liabilities, like impending Corporation Tax, can suddenly thrust a company into insolvency.

HMRC’s stance is clear-cut: if you’re a director, you should have known.

Every director must be abreast of the company’s financial health, and the responsibility for this oversight rests squarely on their shoulders. Acting in good faith isn’t an adequate defence. If you’re trading while insolvent and have issued unlawful dividends, expect pressure to justify every decision.

In such scenarios, seeking advice from experts can be a lifeline.

Repercussions for Directors

If dividends are deemed unlawful, the implications can be harsh:

• Reclassification by HMRC: Dividends could be reclassified as salaries, attracting National Insurance and Tax.
• Personal Liability: If the company becomes insolvent and a shareholder isn’t obliged to repay an unlawful dividend, directors might be pursued for the payment.
• Insolvency Concerns: Continuation of trade during insolvency is a major offence if you’re not prioritising the best interests of creditors.

The overarching message? A slip in dividend procedures can spiral into a series of complications and legal entanglements.

Conclusion

Unlawful dividends aren’t merely a financial oversight; they can become a legal mess. As a director, understanding the nuances of dividends, maintaining impeccable records, and regularly assessing company health are non-negotiable.

The ramifications of getting it wrong are severe, both for the company and personally as a director. Taking preventive measures, seeking expert advice when needed and ensuring that each step is compliant with the Companies Act can help keep you clear of trouble.