Dividends paid when reserves are negative

Company with negative equity has paid out dividends confirmation needed that it is illegal

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A company I have just taken on shows the following position

Reserves 30/11/20 -£26,449, Reserves 30/11/21 -£26,484, Profit for the year ending 30/11/22 £20,465, Dividends paid 30/11/21 £20,500. The balance sheet is showing a negative equity of £26,484, it has a significant external creditor of £50,000 being a Covid bounce back loan. I am preparing the accounts for the year ending 30/11/22 (not late as yet as we applied for a filing extension) and the position has not changed much, some of the loan has been repaid but more dividends have been taken

I just want to check my own sanity in as much that I am correct the previous accountant should have acted on the illegal dividend made in the accounts for the year ending 30/11/21 (possibly the previous year too) and either transferred to DLA with the subsequent CT implications or declared as an illegal dividend in the Directors PAYE record with the subsequent NI implications. The previous accountants were a sizeable firm, so I cannot underestand why they would miss this, or am I missing something??? 

 

 

Replies (17)

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paddle steamer
By DJKL
28th Nov 2023 13:46

Cm15221 wrote:

A company I have just taken on shows the following position

Reserves 30/11/20 -£26,449, Reserves 30/11/21 -£26,484, Profit for the year ending 30/11/22 £20,465, Dividends paid 30/11/21 £20,500. The balance sheet is showing a negative equity of £26,484, it has a significant external creditor of £50,000 being a Covid bounce back loan. I am preparing the accounts for the year ending 30/11/22 (not late as yet as we applied for a filing extension) and the position has not changed much, some of the loan has been repaid but more dividends have been taken

I just want to check my own sanity in as much that I am correct the previous accountant should have acted on the illegal dividend made in the accounts for the year ending 30/11/21 (possibly the previous year too) and either transferred to DLA with the subsequent CT implications or declared as an illegal dividend in the Directors PAYE record with the subsequent NI implications. The previous accountants were a sizeable firm, so I cannot underestand why they would miss this, or am I missing something??? 

 

 

I cannot see where the reserves ever go negative based on information
you provide above, can you clarify?

(edit,apologies, just spotted the - used, I dislike -, I prefer brackets or DR/CR)

Thanks (2)
Replying to DJKL:
By Ruddles
28th Nov 2023 13:48

Are you confusing the "-" as a hyphen rather than a negative indicator?

EDIT - ;¬)

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Replying to Ruddles:
paddle steamer
By DJKL
28th Nov 2023 13:56

Initially I was, then realised the negative indicator, just do not like such use. Lets face it, on an excel ETB a negative reserve tends to be a good thing.

Thanks (2)
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By FactChecker
28th Nov 2023 13:51

Also, can you define what you mean by "an illegal dividend" (as opposed to a dividend that ... although legal ... a liquidator, if then appointed, could demand be repaid by the recipient)?

Thanks (3)
Replying to FactChecker:
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By Cm15221
28th Nov 2023 14:19

My understanding is that if the company has negative equity as in this case (£26,449) 30/11/20 and (£26,481) 30/11/21, then dividends cannot be paid and any amounts paid to the Director/shareholder should be added back to DLA.???

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Replying to Cm15221:
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By Cm15221
28th Nov 2023 14:22

Sorry in answer to the second part of your response, strictly speaking is the dividend not illegal if taken out of reserves? ,and if HMRC spot it could demand CT on the ampount?

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Replying to Cm15221:
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By FactChecker
28th Nov 2023 15:47

Per response from Roland195 at 14:24 below, the accounts treatment is a matter of choice ... but us pedants (well me anyway) try to avoid using 'illegal' except where a specific law is being contravened.
And the big issue is not with HMRC but with anyone owed money by the company if it reneges on repayments and tries to close operations when insolvent.

Thanks (4)
Replying to FactChecker:
By SteveHa
28th Nov 2023 15:54

FactChecker wrote:

... but us pedants (well me anyway) try to avoid using 'illegal' except where a specific law is being contravened.

Quite right. the correct term is "Unlawful".

Thanks (3)
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By rmillaree
28th Nov 2023 14:18

not enough info - looks unlikely they could do dividends but what happens if they have seasonal business made 100k profit first half of the year and 80k loss second half of the year ?

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Replying to rmillaree:
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By Cm15221
28th Nov 2023 14:24

The company is not seasonal. pretty stable in the amounts of profit reported roughly £20k p.a but the director/shareholder drains the profit each year leaving the company in continuous negative equity of roughly £20k each year.

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By Roland195
28th Nov 2023 14:24

Someone will be along to take issue with the word "illegal" shortly but the gist of it is that where more cash is drawn than profits to cover it, some firms show it this way (I assume dividends were reported on SA Tax Returns) and some choose to reverse it out against Director's Loan Accounts (which may then go on to be written off etc etc).

A liquidator can pursue the ultra vires dividends but then they would equally pursue the director's loan. For some, it will come down to what paperwork was produced.

Thanks (3)
Replying to Roland195:
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By Cm15221
28th Nov 2023 14:27

So are we saying its ok to continue to report a dividend with negative equity, as long as the company continues to make profits and is able to repay its debt (the bounce back loan) The dividend was reported on the Directors/shareholders personal tax return

Thanks (0)
Replying to Cm15221:
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By Roland195
28th Nov 2023 14:56

If were are talking about a sole director/shareholder then while there are issues with Company Law & Director's Fiduciary Duties, it will only realistically become a problem in the event of company failure but there would be little to choose between paying back a dividend or directors loan (personal tax maybe).

There are likely to be more practical worries here - the negative reserves will impact on the Credit Rating and this indicates that the business is unable to meet the needs of the director.

Thanks (1)
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By Bobbo
28th Nov 2023 14:41

Maybe the previous accountants very much did not miss this, and it was their suggesting of methods in which to correct the position that resulted in their becoming the 'previous' accountants.

Thanks (6)
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By frankfx
28th Nov 2023 16:02

https://www.icaew.com/technical/trust-and-ethics/company-law/paying-divi...

Digest the article.

Then share your views with us.

Thank you.

Thanks (2)
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By Cm15221
28th Nov 2023 16:36

After reading the article it looks like it is a straightforward illegal dividend distribution to me? Or can it be argued that the realised profits (ie the normal annual profit of around £20k) can still be used for dividend distribution? so in effect the capital and Reserves section of the balance sheet would be:

Called up Share Capital £100

Non Trading reserve (£50,000)
Retained Profit £76,384
--------
Retained Earnings £26,384
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TOTAL CAPITAL AND RESERVES £26,484
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Or am I clutching at straws, I am of the opinion that at least in the current years accounts ending 30/11/22 all drawings made by the directors/shareholder should be reclassified as PAYE income. I have been in discussion with the previous accountant by text who agrees this is the only course of action. He has tried to wriggle out of the prior years dividend distribution by saying at the time it was made it was expected the profits would have been higher, doesn't wash really as there was a negative equity brought forward of £26k

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Replying to Cm15221:
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By Roland195
28th Nov 2023 16:59

So what do you think the adverse consequences of this "illegal" dividend payment might be that has you so concerned? It's obviously not ideal but I can't see why you'd take it up with the previous agent.

I don't know where you get the notion that re-classifying as PAYE (whatever that means) is the only course of action open. Why not just account for the drawings as director's loans and tax accordingly under S455?

Thanks (1)