Are you paying dividends legally?

It is common for a limited company to remunerate the directors/shareholders via a combination of dividends and salary.

A dividend can only legally be paid however if there are sufficient reserves in the company to be able to do so. Where shareholders have received a distribution (e.g., a dividend) from the company knowing at the time that there were insufficient reserves available for the purpose, then they are liable to repay the illegal portion. Reserves does not mean the money in the bank account!

It is therefore essential to document the position when dividends are taken, and management accounts should be drawn up and kept as evidence. Remember also that corporation tax on profits needs to be taken into account too.

A couple of simple examples: -

A director decides to pay himself a dividend of £10,000 – there is only £8,000 in reserves – the dividend would be illegal.

A director decides to pay himself a dividend of £10,000 as that is the amount of reserves shown in the accounts – however at least £1,900 corporation tax needs to be allowed for too – so once again this would be an illegal dividend. 

Please contact us if you want to discuss this further or like us to “keep an eye” on this for you going forward to ensure you do not fall foul of this potential “trap”.