Paying dividends properly

Dividends come from distributable profit

A dividend can only be paid out of accumulated realised profit after corporation tax, less any losses and dividends already paid. Not from turnover, not from cash in the bank, and not from money that is really VAT or corporation tax waiting to be handed over.

Bank balance                          £42,000

But that includes:
   VAT collected, owed to HMRC          £8,000
   Corporation tax reserved             £9,000
   Customer deposit for future work     £5,000
                                      --------
Genuinely available                    £20,000

Distributing on the bank balance means
distributing other people's money.

An unlawful dividend

A dividend paid without sufficient distributable profit is unlawful. It does not become a dividend for having been called one. In practice it is reclassified as a director's loan, with all the consequences in the next lesson, and it may have to be repaid to the company.

This most often happens when a director takes regular monthly amounts through a year that turns out worse than expected, and only finds out when the accounts are prepared months later.

The paperwork a dividend requires

• Board minutes recording the decision to declare it
• A dividend voucher for each shareholder, showing the company name, date, shareholder, and amount
• Confirmation that distributable profit was sufficient at that date

This is not optional formality. Without it there is nothing evidencing that the payment was a dividend rather than an undocumented withdrawal, and HMRC's default treatment of an undocumented withdrawal is a loan.

Dividends follow shareholdings

A dividend must be paid on all shares of a class in proportion to holdings. Two equal shareholders cannot take different amounts of the same dividend. Where different amounts are genuinely wanted, that is a matter of share structure, set up in advance, not of paying different sums and calling them dividends.

The bit HMRC does not spell out

Keep interim accounts when declaring dividends during the year. You are asserting that distributable profit exists at that moment, and management figures showing it are what supports that assertion.

Directors who take monthly dividends on the assumption the year will be fine, without checking, are the ones who discover an unlawful distribution at the year end. A ten-minute check each quarter prevents it entirely.

Common mistakes

• Distributing on the bank balance. Much of it is not yours.
• No minutes or vouchers. Undocumented withdrawals default to loans.
• Unequal dividends on the same share class. Not permitted.
• Not checking profit during the year. The year end is too late.