Paying dividends – the essentials
A reminder for directors of micro and other small companies

The rules on dividend payments by companies is complex and it is easy for directors to make mistakes.

Is it a dividend?

Directors who are shareholders often take distributions from their limited companies. This can include gifts, and other transactions at undervalue (e.g. below-market rate loans may be distributions).
Directors frequently pay themselves through dividends (as shareholders), salary (as directors or employees), borrow money through director’s loan accounts, or a mixture of these things.
Directors should document any decision (e.g. minutes of directors’ meetings or shareholder resolutions) as appropriate to reflect the substance of the transaction. While it is normal to produce minutes of a meeting after the relevant meeting, they should reflect decisions taken at the meeting. Documents should not be backdated as this may amount to fraud.

Are dividends different to other types of payments?

A dividend is a distribution of post-tax profits of the company to its shareholders. It is payable to all shareholders (of the same class of share) in proportion to their shareholdings and in accordance with the company’s articles.

Only profits available (after provision for corporation tax) may be paid. The directors can be personally liable for the amount paid if they pay dividends unlawfully.

Further, shareholders are required to repay unlawful dividends received, if they knew of the facts that made them unlawful (even if they did not appreciate that they made them unlawful). Where shareholders are also directors, facts known to them from acting in either capacity will be relevant in this context.

What profits shown in the accounts are “available” to pay dividends?

The starting point for understanding whether a company has profits available to pay dividends will typically be its last annual accounts or management accounts.

The balance sheet in those annual accounts will often show “retained earnings” or “profit and loss reserves”. However, for micro companies the balance sheet will simply show a figure for “capital and reserves”. It is important to determine what element of those reserves qualify as available to pay dividends.

 

Has the financial position deteriorated since the accounts?

Directors need to consider whether the position has deteriorated since the date of the accounts used for assessing profits available to pay dividends. If the realised profits in those accounts have been reduced by subsequent losses, then a dividend cannot be paid out of them to that extent.

The longer the gap between the date of the accounts and the proposed dividend payment, the greater this risk may be. We therefore recommend using cloud accounting software or creating a mini profit and loss summary in your excel files for you to regularly review.

Has the financial position improved since the accounts?

Directors may consider that the financial position has improved since the date of the accounts used for assessing profits available, potentially allowing more dividends to be paid.

In this case, new accounts (referred to as “interim” or “management” accounts) should be prepared to determine the profits are available.

These should follow the same principles that apply for calculating available profits outlined above.

For e.g., if the directors want to use management accounts for this purpose, they will need to take into account tax on profits to the relevant date and consider other adjustments that might be required in statutory accounts but that have not been included in management accounts, such as depreciation.

Should the company pay dividends even if it has profits available to do so?

Even if the company has profits available for distribution under the legal tests outlined above, directors should consider the practical consequences that might arise from paying dividends, including the impact on the company’s cash flow.

For instance, will the company face loan repayment obligations for which cash will be required? If the company does not have cash reserves, will it be able to borrow cash on reasonable terms and, more importantly, would it be prudent for it to do so (in order to pay dividends)? Directors should consider whether the company will still be solvent following a proposed dividend or other distribution.

This means considering the immediate cash flow implications of a dividend and the continuing ability of the company to pay its debts as they fall due. Directors of a company in financial difficulties should consider seeking further advice.

Directors may wish to also consider their overall personal tax position and the effect further dividends may have on their self assessment income tax liability.

What is the process for paying dividends?

Directors should first check that they have considered the matters outlined above, in particular:
• that the intended dividend is covered by the balance of realised profits within the last annual accounts or in more up to date interim accounts;
• that those realised profits have not been subsequently lost;
• the dividend payments would not leave the company unable to pay its debts as they fall due.

A company’s articles of association typically set out the process for paying dividends (e.g. see article 30 of the UK’s model articles for private companies limited by shares). So-called “final” dividends are usually paid annually after the annual accounts have been approved.

The articles typically (and the model articles do) provide:
• for the directors to recommend a dividend
• for the dividend to be declared by ordinary resolution (e.g. by vote at an AGM or written resolution)
• that the members cannot vote to pay more than the amount recommended by the directors. Articles also typically (and the model articles do) provide for the directors to pay “interim” dividends at any time. The tests of lawfulness of a dividend need to be applied not only at the start of the process but up to the point at which the dividend becomes a legally binding liability on the company.

This occurs when:
• a final dividend is declared by the members (even if, as is usual, stated to be due at a later date); or
• at the point when an interim dividend is actually paid.

The company should keep appropriate records relating to the payments, e.g. evidence that the dividend was supported by relevant accounts and minutes of directors’ or shareholders’ meetings.
Under tax legislation, the company must send to the shareholder a certificate stating the amount of the dividend and the date of the payment.

Moore Accountancy have sample dividend summaries and board meetings which you can tailor to your individual needs.