Are you aware of the possible legal repercussions of paying unlawful dividends?
What is a legal dividend? Paying a dividend is the usual way for a company to distribute a share of its profits among the shareholders. Part 23 of the Companies Act 2006 establishes what profits are available for distribution by dividend, and what accounts are required in order to justify a dividend. If these requirements are not met, a dividend is unlawful. A recent case has outlined a consequence of a dividend not being paid in line with the legal requirements.
The facts and the Liquidator’s claims
In the case of Re BM Electrical Solutions Ltd, Michael Edward Belcher, the sole shareholder and director of the company, had agreed to a low salary of £11,702 (net) on the basis that he could claim further monies in the form of dividends as a means of saving tax. The company ran into financial difficulties due to a significant bad debt from a customer and, because of issues with HMRC related to tax alleged to be due, HMRC subsequently presented a winding up petition against the company. This led to the company being wound up on 3 August 2015. The liquidator found that over a three-and-a-half-year period, over £220,000 worth of transfers had been made to Mr Belcher without clear reasoning. At trial, Mr Belcher claimed that a small proportion of the monies transferred were his salary whilst the rest of the payments were recorded as ‘dividends’ on the accounting software for the company as a tax efficiency measure. The liquidator also noted the company had only ever filed one set of accounts on 11 August 2012 for the period of 31 January 2012.
The court’s decision
Judge Lance Ashworth QC held that the monies paid to Mr Belcher as ‘dividends’ were to be treated as director loans and not as legal dividends in line with the findings of the liquidator. Two fundamental reasons were given for this. In order for a dividend to be legally paid to a shareholder, it must be declared. As Mr Belcher could not prove such declaration had been made, he could not maintain that the payments received should be treated as legal dividends. Secondly, in line with the declaration of a dividend and in accordance with Part 23 of the Companies Act 2006, for a company to pay a dividend, it must be paid out of profits available for the purpose, and those profits are to be determined by reference to profits, losses, assets and liabilities consistent with relevant accounts. As the company had failed to produce and file accounts, even if the dividends had been declared, the dividends would still be classed as unlawful. As there was no distribution, the monies paid to Mr Belcher were therefore paid as a director loan and, as such, must be repaid to the company. Mr Belcher was ordered to repay more than £188,000 to the company.
This recent judgment highlights the importance of ensuring dividends are declared in line with Part 23 of the Companies Act 2006 and a clear example of the legal consequences shareholders can face should the procedure of paying dividends not be followed.
Prior to paying a dividend, you must ensure a board meeting of the directors is held to declare the dividend in which a set of accounts are produced showing the company has sufficient profits to do so.