Paying dividends can be a complex matter and mistakes can easily happen. The result of making a mistake can result in action being taken and potential prosecution.
The guidance below has been written for micro and small businesses as those larger tend to have more complex issues and so need a different approach.
What is a dividend?
The law on distributions not only applies to dividends but all kinds of distributions to shareholders. Often with micro and small companies, the directors are also the shareholders of the company and therefore pay themselves a mixture of distributions such as remuneration, dividends and borrowings in the form of a director’s loan account.
The law on distributions such as dividends is based on the nature of the transaction and not necessarily how it is described in documentation. It is therefore vitally important for directors to document decisions made regarding dividends in board minutes or shareholders resolutions to correctly establish the transaction and how it should be accounted for.
Dividends are distributions paid from profits after tax to its shareholders. The dividend is payable based on shareholding types and the number of shares held in the company, it is important to note that even if the director is not the shareholder the director will be personally liable if a dividend was paid unlawfully.
Unlawful or illegal dividends are dividends which are paid out to the company where there are no distributable profits available.
How do I decide what dividends can be paid from the accounts?
Dividends are paid from profits after corporation tax and therefore a good starting point is to look at the available retained earnings on the balance sheet. For micro and small businesses, the retained earnings often have the capital and reserves shown as one simple figure, therefore it is important to understand if this includes realised and unrealised reserves.
Unrealised reserves will include transactions such as revaluations and inter group balances, whereas realised reserves tend to be profits from normal trading activities. Once established the directors can then review if a dividend can be paid and how much it would like to pay its shareholders.
Declaring a dividend and looking to the future
It is important for directors to look at the trading position of the company when deciding on dividend payments because if the company’s trade has deteriorated (e.g., pandemics, loss of key customers or technology advancement) then dividends may not be available to distribute as the company may need the funds to continue trading. Directors must also be aware of the company’s obligations and debt payments before committing to a dividend payment.
If, however, the company’s trading position has improved during the year the directors may wish to pay a dividend early based on current accounts to date. A dividend payment made at this point will be called an ‘Interim Dividend’.
For each dividend payment, the company issues a voucher to the shareholder and one to stay within the company records. The voucher needs to display:
The date of the dividend paid
Company name
Name of the shareholder being paid
Amount of the dividend and the class of share
Tax-efficient dividends
As most micro and small companies tend to be the same shareholder and director then the most efficient way to extract funds is to pay a combination of a low salary and dividends. The salary will be tax-deductible from the company profits and the dividend as mentioned will be based on available retained earnings.
Care and consideration need to be taken when deciding how much to extract from the company both from a company and a tax on shareholder point of view.
We can help!
If you would like further help and advice with your limited company, please get in touch and Cube Accounting will be happy to support you through your business journey.