Withdrawing profits from your limited company using dividends can be a tax-effective way of receiving an income, particularly when compared with drawing a salary.
However, strict rules, encoded in the Companies Act 2006, govern your duties to the company, if you are a director.
A recent case demonstrates how HMRC are able to go back to the source of information and transactions in deciding whether a payment should be taxed as a dividend or as salary.
Regardless of company structure, dividend payments are unlawful when insufficient profits exist to cover the amount paid.
This was recently upheld in the case of Global Corporate Ltd v Hale, in regards to the rules regulating the payment of dividends to shareholders in the event of liquidation.
Between 24 June 2014 and 26 October 2015, payments described as ‘dividends’, which totalled £23,511, were paid by Global Corporate Ltd to the now former director, Mr Hale, despite the company having insufficient profits to cover the payments.
Global Corporate Ltd argued that the director was responsible for taking the dividends, and therefore owed the company and its creditors.
However, the court ruled that it was, in fact, the company who should take responsibility for the repayment of the dividends, as “companies must have sufficient reserves to pay dividends at the time they pay them, whether or not they intend to rectify any deficiency at the end of a tax year”.
It means that Global Corporate Ltd now must cover the payments despite having paid it out to a director some years previously.
What steps should you take?
Your fiduciary duties mean that you can only pay and receive dividends in certain circumstances. Should you breach these duties, you can become liable for repaying any unlawful duties that have been paid, both to yourself and to any non-director shareholders.
To be legal, all dividends must be paid from distributable profits. This means that you must not pay more in dividends than the profits available from the current and previous financial years.
You should refer to your statutory accounts for the relevant period in order to ensure that sufficient profits are available. Where there is any doubt, it could be advisable to have interim accounts prepared to clarify that you have sufficient profit.
You must also hold a directors’ meeting which formally declares the dividend to be paid, and this meeting must be properly minuted.
Additionally, correct paperwork must be prepared in respect of every dividend that your company pays. This must take the form of a dividend voucher, which should include the date of the payment, the name of the company, the names of the shareholders and the amount of the dividend. A copy must be given to the recipient and a copy must be retained by the company.