WHEN IS A DIVIDEND NOT A DIVIDEND?
No, not a low quality joke from my Dad, I promise! Many small limited companies set up their directors pay so that they have a small monthly salary that is tax efficient and then top it up with monthly or quarterly dividends – which is perfectly legal and tax efficient, but there are a few key things to remember:
Does the business have “distributable reserves”?
I know I try and avoid getting technical on here, but sometimes it can’t be helped. In order to pay dividends the business needs to have “distributable reserves” in basic terms it needs to have accumulated profits which means not just the current year being profitable but from when it started to trade, there can be losses in there from some years but overall it needs to add up to a profit.
You need to look back at how your business has traded over the past years and take all those profits after tax less any dividends and if it’s a positive number then you are OK to pay a dividend, if it’s negative you aren’t. These bought forward figures are the opening reserves figure on your balance sheet (your accountant will be able to show you this figure if you are unsure).
There are four different possibilities:
Opening reserves are positive and you have a profit in the year: Dividends are OK
Opening reserves are positive and you have a loss in the year: If these added together are positive then dividends are OK, but if these added together are negative then dividends are not OK
Opening reserves are negative and you have a profit in the year: If these added together are positive then dividends are OK, but if these added together are negative then dividends are not OK
Opening reserves are negative and you have a loss in the year: Dividends are not OK
Dividends can only be paid when you get a “dividends are OK” response .. otherwise they are classed as “illegal dividends” (more on this in a bit).
Does the business have the cash to pay dividends?
Seems a pretty straight forward one – can the business afford to pay you a dividend and also to pay its other liabilities? You should ensure you are leaving enough cash in the business to pay the tax bill and any other bills that you know you need to cover.
Is there a directors’ loan account?
If the business owes cash to the director(s) then repaying this is generally seen as a good idea and this can be repaid even if business cannot pay dividends, this can happen when there are historical losses and the business has turned a corner and is now profitable but hasn’t yet got into an overall positive position. Paying back a directors loan account doesn’t have any tax implications for the business and, unless interest is being paid, doesn’t have any tax implications for the director either.
Oh “bother”, I paid dividends and I shouldn’t have
So, you’ve now gathered that paying a dividend when you shouldn’t isn’t great – it’s technically called an illegal dividend which sounds so much worse than it is. Under the Companies Act 2006, if a dividend has been paid illegally then the shareholders are required technically required to repay them.
For a privately owned company where you are the shareholder and the director, then you aren’t necessarily going to repay these dividends, but they should be treated as loans within the business records and if the business needs the cash back then you would have to, or if the business were to fold then insolvency procedures would need you to repay them.
If you have already declared them in your self assessment then you will need to redo and resubmit that self assessment tax return as well with the correct figures.
So, what should you do so that you get it right?
If you keep your records electronically in software then you can easily check that you are OK to pay a dividend, but if you are running a spreadsheet and your results are more borderline then you won’t necessarily have this information to hand. In this case, you ought to be pulling together some basic financial information each time you want to pay a dividend: income for the year to date less spend for the year to date will give you a basic profit figure. Then take off 19% for your corporation tax to see where you are at. If this plus your opening reserves are positive, then you should be OK. It’s not a precise science as there’s more than it to this for doing your company accounts and corporation tax but it will aid you in these decisions.