You should be aware of several distinctions between legal and illegal dividends as a corporation. Many firms have reviewed their dividend policy in light of the Coronavirus outbreak. Many corporations’ financial positions are expected to have deteriorated dramatically since their previous annual financial statements.
According to the Companies Act of 2006, a dividend can only be paid if adequate distributable earnings exist. The bank account may be in good standing. However, the corporation must have enough retained earnings to cover the dividend by the due date.
Dividends to shareholders are the most common way business owners extract earnings from their businesses. In most circumstances, this is a simple process, but what if you accidentally declare dividends that are more than the value of your available profits?
What Exactly Is an Illegal Dividend?
A corporation can issue a dividend if it has sufficient profits and excess sales over expenditures and taxes. Unfortunately, it’s very uncommon for contractors to overpay dividends by declaring them based on the company’s bank account rather than earnings and without first reviewing management accounts for profit levels.
When Corporation Tax is determined at the end of the year, the available earnings are reduced, and the dividend paid becomes a loss. Dividends should only be paid from profits. Hence, this is regarded as an unlawful dividend or Ultra Vires.
Before announcing a dividend, a director must ensure there are adequate earnings. This can be as simple as reviewing your management accounts.
What Happens if You Take a Payout Without Permission?
If the company’s directors announce an unlawful dividend, it is not considered a criminal offence— and you will not be sentenced to prison as a result!
However, suppose you failed to use reasonable caution by failing to prepare management accounts to assess earnings before declaring a dividend. In that case, you may be liable to the business for repayment of that dividend.
If you paid an illegal dividend, the quickest fix is to refund the money to the corporation, assuming it was an interim dividend. If that’s not possible, you can wait. Future sales might generate enough revenue to restore your profit position.
HMRC has issued technical instructions in support of reimbursing an unlawful dividend.
Conclusion
HMRC may initiate an investigation into the handling of a dividend in any situation, not only in liquidation. HMRC views an unlawful dividend as similar to a loan. For a ‘close’ business, this means a loan to a participator, which must be recorded on the company tax return..
They may initiate an investigation if such a ‘loan’ is not disclosed and the company’s reserves are in deficit after the relevant period. In the same way, if the beginning balance for the next year is negative, dividends will still be paid.
HMRC has also claimed that the repayable sum is an interest-free loan, resulting in a taxable benefit-in-kind for a director employee if the loan is less than £10,000.
For further help, contact McCarthy Browne.
