Paying dividends - the essentials

The law on distributions (described further below) applies not only to dividends, but also to any other form of distribution to shareholders. Put very simply, a distribution is a transaction that transfers value to a shareholder (or related party) and the terms were arrived at because the other party was a shareholder (or related party).

This includes gifts and other transactions at undervalue (eg below-market rate loans may be distributions). Directors who are also shareholders frequently pay themselves through dividends (as shareholders) or remuneration (as directors or employees) or borrow money through director’s loan accounts, or a mixture of these things.

The law on dividends (and other forms of distribution) applies to the substance of the transaction, not merely because of how it is described in the related documentation. It is therefore important that directors understand the nature and consequences of the alternatives open to them before they proceed.

Directors should document any decision (eg minutes of directors’ meetings or shareholder resolutions) as appropriate to reflect the substance of the transaction. While it is normal to produce minutes of a meeting after the relevant meeting, they should reflect decisions taken at the meeting. Documents should not be backdated as this may amount to fraud. See Q8 below for information on the process involved in paying dividends.

A dividend is a distribution of post-tax profits of the company to its shareholders. It is payable to all shareholders (of the same class of share) in proportion to their shareholdings and in accordance with the company’s constitution (articles).

The law on dividends applies also to coupons payable on preference shares. Only profits available for the purpose, in accordance with company law rules and procedures, may be paid. The directors can be personally liable for the amount paid if they pay dividends unlawfully.

Further, shareholders are required to repay unlawful dividends received, if they knew of the facts that made them unlawful (even if they did not appreciate that they made them unlawful). Where shareholders are also directors, facts known to them from acting in either capacity will be relevant in this context.

The starting point for understanding whether a company has profits available to pay dividends will typically be its last annual accounts circulated to shareholders.

The balance sheet in those annual accounts will often show “retained earnings” or “profit and loss reserves”. However, for micro companies the balance sheet will simply show a figure for “capital and reserves”. It is important to determine what element of those reserves qualify as available to pay dividends.

In law, these are profits that meet a test of being “realised profits”. Profits from normal trading activity are typically (but not automatically) realised profits.

The face of the accounts may not distinguish between profit reserves that are realised or unrealised. For example, some companies have transactions that result in entries in reserves that are unrealised (such as revaluations of properties or certain intra-group transactions). Care is needed to make sure dividends are only made from realised profits.

For companies subject to audit requirements under the Companies Act 2006, additional considerations apply where the auditor’s report is qualified. In particular, under s837(4) of the Companies Act 2006 an auditor’s statement will be required stating that the qualification does not affect the proposed dividend (if that is the case)

Directors need to consider whether the position has deteriorated since the date of the accounts used for assessing profits available to pay dividends. If the realised profits in those accounts have been reduced by subsequent losses, then a dividend cannot be paid out of them to that extent.

The longer the gap between the date of the accounts and the proposed dividend payment, the greater this risk may be.

Directors may consider that the financial position has improved since the date of the accounts used for assessing profits available, potentially allowing more dividends to be paid.

In this case, new accounts (referred to as “interim accounts”) should be prepared to determine the profits are available.

Interim accounts should follow the same principles that apply for calculating available profits outlined above.

For example, if the directors want to use management accounts for this purpose, they will need to take into account tax on profits to the relevant date and consider other adjustments that might be required in statutory accounts but that have not been included in management accounts, such as impairments.

Even if the company has profits available for distribution under the legal tests outlined above, directors should consider the practical consequences that might arise from paying dividends, including the impact on the company’s cash flow.

For instance, will the company face loan repayment obligations for which cash will be required? If the company does not have cash reserves, will it be able to borrow cash on reasonable terms and, more importantly, would it be prudent for it to do so (in order to pay dividends)? Directors should consider whether the company will still be solvent following a proposed dividend or other distribution.

This means considering the immediate cash flow implications of a dividend and the continuing ability of the company to pay its debts as they fall due. Directors of a company in financial difficulties should consider seeking appropriate professional advice.

The key thing in relation to groups of companies is that profits available for distribution are calculated at the individual company level and based on the accounts for that company. If a company has accumulated losses, it cannot pay dividends even if the group (including its own subsidiaries) is profitable.

Intra-group transactions are common within groups of companies. For instance, one company may transfer a property to another at cost (below market value), transfer of tax losses for a consideration that is not arm’s length or leave the price as an intra-group loan. Undervalue transactions require careful consideration by the companies involved, and this is an area where professional assistance is advisable.

Directors should first check that they have considered the matters outlined above, in particular:

• that the intended dividend is covered by the balance of realised profits within the last annual accounts circulated to shareholders or in more up to date interim accounts;
• that those realised profits have not been subsequently lost;
• the dividend payments would not leave the company unable to pay its debts as they fall due; and
• if the company is subject to audit, the legal requirements applying where the auditor’s report is qualified.

A company’s articles of association then typically set out the process for paying dividends (eg see article 30 of the UK’s model articles for private companies limited by shares). So-called “final” dividends are usually paid annually after the annual accounts have been approved.

The articles typically (and the model articles do) provide:

• for the directors to recommend a dividend
• for the dividend to be declared by ordinary resolution (eg by vote at an AGM or written resolution)
• that the members cannot vote to pay more than the amount recommended by the directors. Articles also typically (and the model articles do) provide for the directors to pay “interim” dividends at any time. The tests of lawfulness of a dividend need to be applied not only at the start of the process but up to the point at which the dividend becomes a legally binding liability on the company.

This occurs when:

• a final dividend is declared by the members (even if, as is usual, stated to be due at a later date); or
• at the point when an interim dividend is actually paid.

The company should keep appropriate records relating to the payments, eg evidence that the dividend was supported by relevant accounts and minutes of directors’ or shareholders’ meetings. Under tax legislation, the company must send to the shareholder (or the bank or building society if the dividend is paid into a bank or building society account) a certificate stating the amount of the dividend and the date of the payment.

ICAEW’s guide on directors’ duties and responsibilities

Including:

• general duties (eg to promote the success of the company),
• record keeping
• implications if a company is in financial difficulty (including duties to creditors when the company is insolvent or likely to become insolvent)
• other transactions with shareholders, including share buy-backs 

• ICAEW’s guide on directors’ duties and responsibilities

ICAEW’s Introduction to the Law on Dividends

More detail on the legal framework for paying dividends, including the law on unlawful distributions under the Companies Act 2006 .

• Introduction to the Law on Dividends

ICAEW and ICAS, Tech 02/17 BL

Detailed consideration of technical application of the law to certain circumstances (eg Chapter 9, group companies)

• TECH 02 17 BL Guidance on realised and distributable profits under the Companies Act 2006

ICSA’s guide on withdrawal and amendment of dividend resolution

Includes commentary on when a dividend becomes a debt of the company.

• Read more

HMRC Taxation Manual: Distributions: general: dividends, distributions and company law

Summary of the distributable profits regime and related tax matters.

• Read more