The ‘tax point’ of dividends received by shareholders of family or owner-managed companies can sometimes cause difficulties.
The tax legislation is not very prescriptive about when tax is charged on dividends (and other distributions) received by individuals. It simply states: ‘Tax is charged under this Chapter [i.e., on dividends etc. from UK resident companies] on the amount or value of dividends paid and other distributions made in the tax year’ (ITTOIA 2005, s 384(1)). Different rules apply to dividends from share incentive plans.
Company law
Of course, this tax treatment is on the footing that a legal right to the dividend has been established. Lawful dividends are broadly those that comply with company law requirements, which are beyond the scope of this article but which generally include checking whether the company has sufficient distributable profits for a dividend to be paid (CA 2006, s 830(1)).
Furthermore, the company’s Articles of Association will generally set out a procedure for the declaration of dividends. For example, the model Articles of Association for private companies limited by shares (NB this document is available on the Gov.uk website) provides that the company may by ordinary resolution declare dividends, and the directors may decide to pay interim dividends (Article 30(1)).
The distinction between interim and final dividends is an important one:
- Interim dividends are legally due and payable when actually paid. A resolution to pay an interim dividend can be varied or rescinded. Therefore, the resolution does not create a debt until the dividend is paid. In Potel v CIR (1971) 46 TC 958, S Ltd declared an interim dividend on 31 March 1965, and sent a circular to its shareholders stating that it intended paying the dividend on 29 May 1965. The court held (inter alia) that the dividends formed part of the appellant’s total income for 1965/66, as the resolution to pay an interim dividend did not create a debt before the dividend was paid.
- Final dividends must be recommended by the directors and approved by the shareholders in general meeting. Final dividends are legally due when declared unless a later date for payment is specified, in which case the debt is enforceable and such dividends are due on that payment date. Although dividends voted in a general meeting are often referred to as ‘final’, there is (at least in theory) no restriction on the number of dividends that may be declared by the members each year in properly constituted general meetings.
Due and payable?
The general rule is that ‘[f]or the purposes of the Corporation Tax Acts dividends are to be treated as paid on the date when they become due and payable (CTA 2010, s 1168(1)). The income tax provision on dividends in ITTOIA 2005, s 384(1) is part of the ‘Corporation Tax Acts’ as it relates to the taxation of company distributions and includes provisions relating to income tax (IA 1978, Sch 1). Thus, a dividend is subject to income tax in the hands of an individual shareholder when it becomes ‘due and payable’.
When a final dividend is declared (without any stipulation as to the date for payment), the declaration of the dividend creates an immediate debt (In re Severn and wye and Severn Bridge Railway Company [1896] 1 Ch 559).
As far as interim dividends are concerned, in Potel, Brightman J commented: “In my view…in the case of an interim dividend which the directors resolve shall be paid, they can at or after the time of such resolution decide that the dividend shall be paid at some stipulated future date. If a time for payment is so prescribed, a shareholder has no enforceable right to demand payment prior to the stipulated date.”
Potel concerned the declaration of interim rather than final dividends. However, Brightman J considered that no substantive difference arose between his analysis in respect of the final dividends and interim dividends in that case.
Unreserved right
HMRC’s guidance on dividends, distributions and company law (in the Company Taxation manual at CTM15205) confirms: ‘An interim dividend…may be varied or rescinded at any time before payment and may therefore only be regarded as due and payable when it is actually paid.’
As to when the payment of a dividend is considered to have been made, HMRC states: ‘payment is only made when the money is placed unreservedly at the disposal of the directors and shareholders as part of their current accounts with the company. Payment is not made until such a right to draw on the dividend exists…’ (emphasis added).
It is common in family and owner-managed companies for interim and final dividends to be credited to the individual shareholder’s director’s loan account. The question arises as to when a dividend amount has been placed unreservedly at the shareholder’s disposal. HMRC considers that the right to payment does not exist until the appropriate entries are made in the company’s books.
However, what is the tax position if a dividend credited to a shareholder’s loan account is subject to a restriction on the freedom to withdraw it? This point was considered in Jays v Revenue and Customs [2022] UKFTT 420 (TC).
Declared but withheld and unpaid
In Jays, the appellants (MJ and KJ) were shareholders of a property management company (QPL). They held the single issued share jointly and MJ was the sole director. QPL took out loans and purchased interest rate hedging products from Lloyds Bank. QPL was trading well, but the interest costs were so debilitating the business was at risk. MJ wanted to attract external equity investors into QPL and believed that showing strong dividend declarations would make the business attractive to such investors. However, Lloyds were unwilling to permit MJ and KJ to extract substantial profit from the business. The appellants provided an undertaking to Lloyds, restricting their dividends for 2013/14, 2014/15 and 2015/16 to an upper amount.
QPL’s accounts for the year ended 31 December 2014 showed dividends (declared on 23 December 2014) of £90,000. However, it was resolved that a ‘provisional’ dividend of £45,000 be declared in favour of KJ, but only £29,000 was to be made available at this point. The remaining £16,000 was to be credited to a ‘blocked’ account and held in abeyance. For QPL’s accounting period ended 31 December 2015 dividends were declared of £206,000 (i.e., £103,000 each), of which £39,000 and £73,000 were credited to blocked directors accounts for MJ and KJ respectively. For QPL’s accounting period ended 31 December 2016, dividends were declared of £139,000 (i.e., £69,500 each), of which £39,500 was credited to a blocked account for KJ. HMRC issued discovery assessments and penalties. On appeal, the issue for the First-tier Tribunal (FTT) was whether the dividends in question ‘became due’ when declared, or when paid.
The FTT found that all the dividends declared for the years ended 31 December 2014, 2015, and 2016 were final dividends. The FTT’s view was that the declaration of dividends subject to stringent stipulations had the legal effect of deferring the date on which the stated proportion of the dividends was payable. The dividends declared by QPL but retained as unpaid and inaccessible did not give rise to an enforceable right to receive the dividends as income.
Conclusion
For further commentary on the payment of dividends
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