An unlawful dividend, also known as an illegal dividend or unlawful distribution, can occur in six different ways:
- There are insufficient profits in the company
- It was drawn without reference to the relevant account
- The company was insolvent when paying the dividend
- The dividend wasn’t properly declared and backed up with meeting minutes (even if you are a sole director, you still need to provide meeting minutes to HMRC)
- The dividend was backdated
- The money was withdrawn without being properly identified through a dividend voucher
You can still be held personally liable as a company director for paying illegal dividends even if you declare a lack of knowledge or awareness of the rules surrounding dividends.
If the dividend exceeds the company’s retained profits, you cannot cancel it. Instead, HMRC is likely to treat it as a loan from the company to the shareholder.
But what does this mean for the shareholder? If the recipient knows, or should have known, that the dividend payment is illegal, they are liable to repay the amount back to the company.
The shareholder has nine months and one day from the end of the accounting period in which to repay the dividend. If they fail to do this, it will be treated as a ‘benefit in kind’.
What does this mean for the company? The company will be subject to a ‘section 455’ Corporation Tax charge of 33.75% of the repayable amount; additionally, if the loan is greater than £10,000 at any time during the tax year, additional interest will be charged.
If the company writes off the loan, it will need to pay employers’ Class 1A National Insurance through payroll.
What does this mean for the shareholder? They will be required to report the income through the Self-Assessment tax return.
If HMRC feels they cannot recover the Corporation Tax from the company, they may pursue the beneficiary of the dividend directly for the tax due.
What happens if the company has entered liquidation and cannot repay? In this case, the liquidators or administrators will pursue the directors for the repayment. One point to note here is that this isn’t limited to illegal dividends they’ve received, but also the ones they’ve authorised. This is because illegal dividends are classed as a breach of fiduciary duty and classed as misfeasance, the penalty of which is to reimburse the company for the improper use of funds.
If the illegal dividend leads to company insolvency, the director can be prohibited from acting as a director for two to 15 years, along with a financial penalty.