A dividend paid when the company does not have enough distributable profits is unlawful, and the law does not care that it was an honest mistake. The money may have to go back. If it does not, HMRC can treat it as a director’s loan and charge the company Corporation Tax on it at 35.75%.
It is the most common company law breach in owner-managed businesses, and almost always discovered after the fact — when the accounts are prepared and the reserves turn out to be smaller than the drawings.
What makes a dividend unlawful
Part 23 of the Companies Act 2006 governs distributions. Two sections do the work.
Section 830 says a company may only make a distribution out of profits available for the purpose: its accumulated, realised profits not already distributed or capitalised, less its accumulated, realised losses not already written off in a properly made capital reduction.
Two words there matter.
Accumulated. The test is cumulative, running from incorporation — not a single year. A company that made £80,000 last year but lost £120,000 across the two years before has no distributable profits, however good the current year looks.
Realised. Unrealised gains do not count. An upward revaluation of a property is not distributable. Neither is a fair value gain on an investment.
Note what is not in the test: cash. A company can have money in the bank and no distributable reserves at all — exactly the position of a business that has been trading at a loss and has since collected its debtors. Directors who treat the bank balance as the ceiling get this wrong routinely.
Which accounts you test against
Section 836 decides the question by reference to “relevant accounts”. Get this part right and most of the rest follows.
| Situation | Relevant accounts | Statutory basis |
|---|---|---|
| Normal case | The company’s last annual accounts | s836(2), s837 |
| The last annual accounts would not support the dividend | Interim accounts | s836(2)(a), s838 |
| First accounting reference period, or before accounts have been circulated for it | Initial accounts | s836(2)(b), s839 |
Here is the point most published content misses. For a private company there is no statutory format, audit or filing requirement attached to interim or initial accounts. HMRC’s Company Taxation Manual states it plainly: for private companies there are no similar statutory requirements, and the accounts need only be sufficient to enable a reasonable judgement of the distributable profits. The hoops in s838 and s839 apply to public companies.
That has a useful consequence. Where the directors properly prepare interim accounts showing sufficient distributable profits, a dividend paid on the basis of those accounts is lawful even if the annual accounts prepared later show a smaller figure.
The reverse is where companies come unstuck. If no interim accounts were prepared at all, the relevant accounts are simply the last annual accounts under s836(2) — and where those do not support the dividend, the distribution contravenes Part 23 directly under s830. (s836(4) is a narrower point: it bites where interim or initial accounts were prepared but fail to comply with the formal requirements of s837, s838 or s839.) Either way there is no retrospective cure by writing the accounts up afterwards.
Consequence 1: the shareholder may have to repay it
Section 847 provides that where a distribution is made in contravention of Part 23, a member who at the time of the distribution knows, or has reasonable grounds for believing, that it was so made is liable to repay it to the company.
A genuinely innocent shareholder is not liable. That protection exists for shareholders in listed companies who receive a dividend with no way of knowing the state of the reserves.
It rarely helps a director-shareholder. HMRC’s guidance is explicit that where a private company is controlled by directors who are also shareholders, such a member ought to know the status of the dividend, and s847 is expected to apply in the majority of those cases. If you signed the accounts, you knew.
Shareholders also cannot agree among themselves to waive the Companies Act requirements. The courts settled that in Precision Dippings.
Consequence 2: HMRC treats the money as a loan
Where the dividend is unlawful and the recipient knew or had reasonable grounds to believe it, the shareholder holds the money as constructive trustee for the company. The dividend is void as a distribution — the company never made one as a matter of company law, so it does not form part of the shareholder’s income for tax.
It is therefore not taxed as a dividend. Instead, HMRC’s stated position is that a close company is regarded as having made a loan to the shareholder under CTA 2010 s455(1), triggering a charge under s455(2).
| When the loan was made | s455 rate |
|---|---|
| On or after 6 April 2026 | 35.75% |
| 6 April 2022 to 5 April 2026 | 33.75% |
Which rate applies is fixed by when the loan arose, not by when the deadline falls. The charge is due nine months and one day after the end of the accounting period and is reported on form CT600A. Relief is available under s458 once the amount is repaid — by cash, by cheque, or by a suitable entry in the loan account. Interest charged in the meantime is not recoverable.
On a £20,000 unlawful dividend arising in 2026/27 and left outstanding, that is a £7,150 Corporation Tax charge nobody budgeted for. And if the balance owed exceeds £10,000 at any point in the tax year, it is also a beneficial loan — reported on form P11D and attracting Class 1A National Insurance at 15%, payable by the company. Class 1 National Insurance through payroll only comes into it if the loan is later written off.
Consequence 3: the directors
Section 847 deals with the shareholder. Directors are exposed separately. Authorising a distribution you knew, or ought to have known, was unlawful breaches the general duties in Part 10 of the Companies Act 2006, and the courts have held directors personally liable to restore unlawful distributions.
For a sole director-shareholder that looks circular. It stops being circular the moment the company becomes insolvent, because it is then a liquidator bringing the claim.
How to fix one
The standard remedy is to unwind it. HMRC’s manual describes the process: reduce or extinguish the dividend, prepare approved accounts showing only the amount the distributable profits support, and adjust the director’s loan account to match.
Where the amount was credited to a loan account and never drawn, and the entry is removed when the approved accounts are prepared, HMRC accepts that no unreserved right to draw ever existed — so no payment was made. Where cash was actually taken, it has to go back, or be re-characterised as salary with PAYE and National Insurance, or left as a loan and dealt with under s455.
None of those is painless.
How to stop it happening
- Check reserves before every dividend, not at the year end. Retained earnings brought forward, plus profit to date, less Corporation Tax on that profit, less dividends already declared.
- Deduct the Corporation Tax. Profit before tax is not distributable profit. This is the single most common error.
- Prepare interim accounts where the last annual accounts do not cover it — a management profit and loss account and balance sheet the directors can reasonably rely on, not a formal exercise.
- Document the decision. A board minute for an interim dividend and a dividend voucher for each shareholder.
- Keep the loan account and the dividend account separate. Mixing them is what makes these situations almost impossible to unpick two years later.
Frequently asked questions
What happens if I pay a dividend and there are not enough profits?
The dividend is unlawful under Part 23 of the Companies Act 2006. If you knew or had reasonable grounds to believe that, section 847 makes you liable to repay it to the company. If it is not repaid, HMRC treats the amount as a loan to a participator under CTA 2010 s455 and charges the company 35.75% on loans made on or after 6 April 2026.
Can a dividend be unlawful even if the company has cash in the bank?
Yes. The test is distributable profits, not cash. Distributable profits are accumulated realised profits less accumulated realised losses, measured from incorporation. A company that has been loss-making but has collected its debtors can have a healthy bank balance and no distributable reserves at all.
Do I have to use the annual accounts to check distributable profits?
Not always. Section 836 allows interim accounts where the last annual accounts would not support the distribution, and initial accounts during the first accounting reference period. For a private company there is no statutory format for interim accounts — they only need to be good enough for the directors to make a reasonable judgement.
What is the s455 charge on an unlawful dividend?
35.75% for loans made or benefits conferred on or after 6 April 2026, and 33.75% for those made between 6 April 2022 and 5 April 2026. The rate is fixed by when the loan arose. It bites where the loan is not repaid within nine months of the accounting period end, is payable nine months and one day after it, is reported on CT600A, and is reclaimable once the amount is repaid.
Can we just re-label the dividend as salary?
Sometimes, but it is not free. Salary attracts PAYE, employee National Insurance at 8% on earnings between £12,570 and £50,270, and employer National Insurance at 15% on earnings above the £5,000 secondary threshold. The payroll has to be corrected too. Whether that is cheaper than the s455 route depends on the amounts and the timing.
Getting director pay right in the first place
Most unlawful dividends are not aggressive planning. They are a director drawing what the bank balance appeared to allow, in a company where nobody tracked reserves month by month.
SmartFiling runs RTI payroll for director-only and small companies from £15 per employee per month, covering auto-enrolment, payslips, P60s and year-end returns. Every client’s work is reviewed by an ICAEW Chartered Accountant, and the whole process is online.
