Directors beware – can you pay that dividend?

With the Coronavirus pandemic impacting our daily lives, it is important to carefully consider the impact this may have on a company’s current and future profitability, as this may affect the company’s ability to declare dividends.  In particular, if losses could potentially exceed accumulated profits, director/shareholders need to take particular care as noted below.

The Companies Act 2006, section 830 defines a company’s profits available for distribution as “its accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital duly made”.

The latest set of financial statements are often used as the starting point for considering the profits available for distribution, but it is necessary to prove that there is sufficient profit at the time of paying a dividend based on all information available at that time. Companies must, therefore, ensure that either reliable management accounts or a set of specially prepared interim accounts are reviewed to ensure that profits are available. These accounts should include adjustments for foreseeable losses and a provision future liabilities such as Corporation Tax.  In the uncertain environment businesses are operating, a set of accounts prepared only a week ago may no longer be accurate.

Consequences of an illegal dividend

If distributable profits are not available to pay the dividends declared, the dividend may be illegal and must be repaid!  This can be a very uncomfortable position for any business owner to be in, especially with the current climate.

Despite the recent relaxation of the wrongful trading laws, a director would still be liable for a breach of their duties by authorising an illegal dividend and this could lead to:

• claims should the business become insolvent; and / or
• possible disqualification as a Director.

What does this mean for remuneration strategies?

In the case of many small and medium sized businesses the directors and shareholders are the same. Due to the difference in tax rates and National Insurance Contributions, it is tax-efficient for directors to be remunerated by way of a minimum salary with the rest of their remuneration being paid by way of a dividend.

However, if there are any concerns about a company’s future trading prospects, it may well be preferable for Directors to accept the tax inefficiencies of paying an increased salary to mitigate the risk of paying an illegal dividend.

Dividend procedure

Please remember that the procedure for the payment of a dividend is;

• Establish the distributable profits
• Determine the total dividends to be distributed
• Calculate the dividend per share
• Hold meetings as necessary to approve the dividend
• Prepare the dividend vouchers and make the payment

Preparing minutes and keeping contemporaneous documentation is more important than ever!

To discuss the topics explored in this article, contact us.