The Companies Act 2006 determines that a dividend withdrawn in excess of the retained profits available is deemed illegal. HMRC acknowledges that illegal dividends can occur, however there are certain ways to prevent them.
Throughout an accounting period, it is important to estimate the profit available at any given time. This can be done through monthly/quarterly interim profit and loss summaries which give a rough picture of the amount that can be legally paid as a dividend. Online accounting software can provide a real-time view of the profit available in a company, and is therefore very helpful when deciding how much to pay.
Another way to ensure that illegal dividends have not been declared come your accounting period end is to leave a small buffer in the company. Paying out slightly less than the estimated profit available should leave enough to account for any adjustments in the financial statements. This provides a safety net to ensure all dividends are legal.
If the dividends declared were unpreventable, company law dictates that the overpaid dividends should be treated as loans to the shareholders. For a contractor operating through a limited company, there are both personal and company implications of a loan:
1.Personal:If a loan exceeds £10,000 at any point in a tax year, interest must be charged at the official rate (currently 3%) upon repayment to the company. If interest is not charged, a benefit in kind must be reported on the employee’s P11d and they will be taxed at their marginal rate.
2.Company:Any loan outstanding at the accounting period end, regardless of its value, must be repaid within 9 months and 1 day of the yearend. If it is not, a Section 455 charge will be applied at 32.5% of the value of the loan which is payable alongside the company’s Corporation Tax. When the loan has been repaid, the company will received a refund of this charge however this is refunded some time after the loan has been repaid.
Ultimately, it is up to the director(s) to declare the company’s dividends and it is important to know the consequences of overpaying dividends.