Paying dividends: only if there are profits in the business
26 February 2021: In the current economic landscape, there are a number of key questions that directors of small companies should ask before undertaking to pay dividends to shareholders.
A dividend is a distribution of post-tax profits of the company to its shareholders. It is payable to all shareholders in proportion to their shareholdings and in accordance with the company’s constitution.
The pandemic, and the ensuing government support, has skewed many companies’ finances but company law rules remain the same: dividends can only be paid where there are post-tax profits to distribute. For many companies that will not be the case at present.
The law on dividend payments by companies is complex and it is easy for directors to make mistakes. A recently published ICAEW guide reminds directors of micro and other small companies that there are essential questions they should ask themselves before they undertake to pay dividends to shareholders under the prevailing circumstances.
Commenting on the guide Charles Worth, ICAEW’s Head of Business Law, states: “The law on dividends is very specific and should not be confused with other payments companies might make to their owner-managers. If you get it wrong, you can waste an awful lot of time putting it right - that is, if you can put it right at all.”
Good business is not just about the law but about the practical implications of business behaviour. One of the questions the guide asks is: “should a company pay dividends even if it has profits available to do so?” The impact on cashflow, loan repayment obligations and whether the company will still be solvent following a proposed dividend are all things the guide flags as important considerations.
Worth urges small companies who are unclear whether they should pay dividends in the current circumstances to get professional advice, especially if they are facing financial difficulties. “Clearly, there may be risk to the business if you distribute dividends and then expected revenue does not come in.”