When is Paying a Dividend "illegal"?

Newsletter Issue - September 2009

A dividend may be 'illegal', in that it is contrary to Company Law, when the proper procedures are not followed. If the Taxman examines the paperwork and decides the payment from your company was not a legal dividend he may treat the amount paid as a loan, or even as a bonus payment.

In both cases additional tax may be due from the company and sometimes from you.

To pay a legal dividend it is not sufficient just to write 'dividend' on the cheque stub or against the entry in director's loan account.

We recommend following these steps when paying dividends...

The directors should first review the profits available for interim dividends. This is not the same thing as cash in the bank, as you have to take account of other assets and liabilities. Those deliberations should be recorded as a formal board minute, so if the Taxman ever asks, you can prove the profits were there when the decision to pay an interim dividend was made.
If the final accounts for the year are complete and show the accumulated profit and loss account is positive, the directors can recommend that the profits, which are not required for investment, can be paid out as a final dividend to the shareholders. The shareholders can either accept the directors' recommendation or suggest a lower figure of dividend. Both these decisions also need to be properly recorded at the time they are made.
Dividend vouchers need to be prepared when either a final or interim dividend is paid, for each shareholder showing the total due, the tax credit attached to the dividend and the date of payment.
The dividend should be paid. The cash can be transferred from the company's account by cheque or bank transfer into the shareholder's own bank account. If the shareholder is a director his account in the company books may be credited with the dividend due to him or her, but this needs to be done as soon as possible after the decision to pay a dividend is taken.

We can help you with all this paperwork, but it is important that the decision to pay a dividend is made in advance of any cash being paid out of the company.