Definition
An unlawful dividend (often called an illegal dividend) is a dividend a limited company pays when it does not have enough profits available for distribution to cover it. Under the Companies Act 2006, dividends can only come from accumulated, realised profits after deducting accumulated, realised losses. The shortfall is often found only when the year-end accounts are prepared, after shareholders already have the money.
What happens next
A shareholder who knew, or had reasonable grounds to believe, that the dividend was unlawful must repay it to the company (Companies Act 2006, section 847). HMRC then treats the payment as a loan to that shareholder, which can lead to section 455 tax if it is not repaid. A shareholder with no knowledge and no reasonable grounds for suspicion does not have to repay, and the payment is taxed as a normal dividend.
Why it happens
Directors of small companies often take dividends based on the bank balance. Cash in the bank can include VAT and Corporation Tax owed to HMRC, so it is not the same as the retained earnings available for dividends. Checking current figures, and year-end accounts that show available profits, reduces the risk.
Lane Ltd brought forward £4,000 of retained profits and made a £2,000 loss this year, leaving £2,000 available. It paid £6,000 of dividends, so £4,000 was unlawful. The guide on what happens when dividends exceed profits goes into more detail.
Related questions
- What happens if I take dividends when the company hasn't made enough profit? The excess is unlawful and may have to be repaid.
- How do I pay myself a dividend legally? Confirm available profits, declare the dividend in board minutes, then issue vouchers.
Related terms
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Retained earnings
Retained earnings are the profits a company has built up since it started, after Corporation Tax, less all the dividends it has paid.
Read definition -
Director's loan account
A director's loan account (DLA) is a limited company's record of money moving between a director and the company other than salary, dividends or repaid expenses.
Read definition -
Section 455 tax
Section 455 tax (s455) is a temporary charge, paid like Corporation Tax, on close company loans to participators, usually director-shareholders…
Read definition
