A dividend is a payment a company can make to shareholders if it has made a profit. … Your company must not pay out more in dividends than its available profits from current and previous financial years. You must usually pay dividends to all shareholders.
A dividend is paid in most cases to shareholders and directors of companies in addition to a basic salary.
The Companies Act 2006 legislation enables shareholders to receive dividends, subject to certain conditions. It is stated that , a dividend can only be paid from profits of the company. This is to protect the position of the company’s creditors so that money is not taken out by the shareholders at the expense of creditors .
How do you declare a dividend?
If a director wishes to pay a dividend to the limited company’s shareholders, he or she must declare the dividend, otherwise it is not created. It is very important that the director reviews what the financial state of the company is likely to be at the year end before declaring a dividend.
To declare a dividend, the board of directors need to pass a board resolution to formalise matters. The resolution should ensure that it refers to the accounts that are relied upon to justify the dividend. These are referred to as the ‘relevant accounts’ accounts.
The reason why dividends are declared is because the shareholders that own the company will want to receive a return on their investment in the company. Such return can typically take two forms:
- receipt of regular dividends
- sale of the shareholding
Dividends can also, but less commonly, be taken in the form of assets, known as a ‘distribution in specie’. Similar principles still apply.
What happens if you fail to declare dividends?
It is important that the dividend is DECLARED as if a payment is made without the declaration, then the transaction is NOT a dividend.
Failure to do this means that the transaction will have to be reversed and repaid to the Company.
What are the conditions for a dividend?
Distributable Reserves
Let’s look at what the legislation states
Dividends can only be declared out of profits. Section 830(1) of the Companies Act 2006 states: “A company may only make a distribution out of profits available for the purpose.” The profits available for a dividend are the accumulated realised profits.
Profits are neither simply cash in the limited company bank account and nor the ‘net’ profit figure shown on the last profit and loss account of the company; they are the accumulated profits. These should be shown on a company’s balance sheet as part of the reserves.
Relevant Accounts
A dividend must be declared with reference to ‘relevant accounts’. These ‘relevant accounts’ are those prescribed by legislation as the form stipulated to enable justification of the dividend. This is a mandatory requirement in Section 836(1) of the Companies Act 2006:
“Whether a distribution may be made by a company without contravening this Part is determined by reference to the following items as stated in the relevant accounts—
(a) profits, losses, assets and liabilities;
(b) provisions of the following kinds—
(i) where the relevant accounts are Companies Act accounts, provisions of a kind specified for the purposes of this subsection by regulations under section 396;
(ii) where the relevant accounts are IAS accounts, provisions of any kind.
(c) share capital and reserves (including undistributable reserves).”
What is an unlawful dividend?
This is when dividends are declared at a point when the company does not have enough distributable reserves.
If companies fail to comply with the above conditions, the dividend will be unlawful.
Consequences of unlawful dividends
The consequence of unlawful and illegal dividends for an insolvent company is that the director will be unable to ratify the breach of duty and liable to repay the dividends back to the company.
Sometimes unlawful dividends are paid to shareholders when the directors incorrectly determine what available profits the company may have. This could be due to a mixture of poor record keeping and/or possibly even inaccurate accounts.
If dividends are paid when a company is insolvent, or it may become insolvent as a result of that payment, then recovery claims may well be brought by the insolvency officeholder against the shareholders and the directors.
Backdating dividends
The strict nature of the dividend rules means that they must be taken seriously. They cannot be addressed as an afterthought after the year-end for accounting purposes to justify a director’s receipt of company money. The dangers of backdating dividends should not be underestimated; you must declare the dividend first and then you can draw it, not backdate it into the accounts after the year-end.
Profits made by a limited company are distributed to shareholders through the declaration of dividends. Quite often, for example in the case of owner managed businesses, the directors and shareholders of the company are the same. In such businesses, directors might take a minimum salary and consider the rest of their remuneration as a dividend.
While some SMEs’ dividends may be considered a tax-efficient means for directors to be remunerated, before a company is able to pay a dividend it must have enough distributable reserves with reference to ‘relevant accounts’.
If these conditions are met, the company then still needs to comply with the declaration formalities before the dividend is paid and not after the event.
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