New practice: Owner/directors of small limited companies whose profits have been hit by COVID-19 may have to repay drawings

Shareholder/directors of many small limited companies take payments from the company (‘drawings’) during their financial year for personal expenses, and debit their loan account with the company to show they owe the company that money. They then repay their loan from a dividend declared in their favour at the end of the year, before the company’s accounts are signed off.

However, it is unlawful for a company to pay dividends unless the company has sufficient accumulated, realised profits to do so. A shareholder/director of a company that does not have sufficient profits to pay such a dividend – which may be the case for many whose finances have been hit by COVID-19 - will therefore have to find some other way to pay off their loan account.

Alternatively, if the company has already paid them a dividend, but they later realise is unlawful because the company did not have sufficient profits, it is the dividend that must be repaid (to the extent that it exceeds the available profits). It is not necessary for the shareholder to realise that the dividend was unlawful, as long as they know the facts that made it so.

The same rule applies not just to dividends but any other transaction (a ‘distribution’) which transfers value to a shareholder in their capacity as such. This could include a gift, or a transfer of an asset to that shareholder at less than its true value.

Operative date

• Now

Recommendation

• Shareholders of companies whose profits have been reduced by COVID-19 but who have continued to take money out of the company should check that they have sufficient available profits to declare a dividend which allows them to pay off their loan and, if not, seek some other way of clearing their loan account.