Case law: Companies cannot say ‘dividends’ paid to directors were in fact salary if the dividends were later found unlawful
Companies and their advisors should be wary of characterising a payment to a director as a dividend without knowing if there are sufficient profits available to lawfully pay dividends, because they cannot later re-classify it as salary if they find there were insufficient profits after all, the Court of Appeal has made clear.
This update was published in Legal Alert - January 2019
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A company director purported to pay himself interim dividends of more than £23,000. When the company later went into insolvent liquidation with losses of around £8,000, it was claimed that the dividends should be repaid as they were unlawful as the company did not have sufficient available profits to pay the dividends at the time. This meant they were unlawful.
The director who made the payments was an engineer with no particular legal or accounting expertise. The practice had been that he paid himself a minimum monthly salary (to ensure National Insurance contributions were up to date) and any excess as a dividend, on the advice of the company’s accountants. Unusually, he signed dividend tax forms each month. At the end of the year, the accountant would then assess whether the company had enough profits from which to pay the dividend and, if not, would re-characterise the payments as salary.
Initially, the High Court decided that the director was not definitively paying a dividend when paying ‘interim dividends’ to himself, despite completing the tax forms. This was on the basis that he knew a formal declaration of dividend, taking account of the accountant’s advice at the time, would be required at the end of the company’s financial year, once the accountant had determined whether there were sufficient profits available for distribution.
The Court also said he did not have enough expertise to see the ‘apparent contradiction’ between signing dividend tax forms during the financial year but only formally declaring a dividend after the year end.
However, the Court of Appeal has overruled the High Court stating that it is not possible:
- to make provisional dividend payments, dependent on whether the company subsequently finds it has sufficient profits to justify dividends; or
- to characterise payments as dividends, but then somehow to re-characterise them as salary at some later date when it discovers it does not have sufficient profits to pay a dividend lawfully.
Therefore, payments structured and described as dividends for tax purposes at the time they were made must continue to be treated as dividends, even if the company subsequently discovered it did not have sufficient profits to pay them. The interim dividends paid in this case were therefore unlawful.
- Companies and their advisors should ensure they do not characterise a payment to a director as a dividend without knowing if there are sufficient profits available to lawfully do so, as they cannot later re-classify them as salary
Case ref: Global Corporate Limited v Dirk Hale  EWHC 2277
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