Dividends v Directors Loans

Correct treatment

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First year trading, Director/Shareholder has declared 14k dividends* in the year, but only made a profit of £3k.  The dla stands at 6k in profit.  (Bills paid before getting a bank account in place 

Can I reduce the divs by 6k by allocating to DLA  (still leaves 8k unwarranted divs) or should it all be put to DLA to create an OD balance of 5.5k, after transferring the nett profit to DLA ?

*Marked as dividends on the bank statement but no voucher produced

Replies (11)

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By johngroganjga
22nd Feb 2023 20:23

If client intended to pay a dividend it’s still a dividend even if in excess of available profits, and not tax-efficient. You should focus your efforts on persuading your client to take your advice before the event next time.

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Replying to johngroganjga:
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By Hugo Fair
22nd Feb 2023 20:38

To be crystal clear, you will often hear that a dividend declared in excess of available profits is an 'illegal dividend' ... which is lacking in pure truth.

As John points out it is inadvisable ('not best practice' if you are feeling polite) ... but this is because if the company then becomes insolvent, the liquidators are likely to demand personal reimbursement to the company of those 'improper' dividends.
However whilst the company continues to trade, a dividend is simply a dividend.

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Replying to johngroganjga:
By Ruddles
22nd Feb 2023 20:39

That old chestnut. Regardless of whether one thinks HMRC are correct one may have to contend with their view of unlawful dividends.

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Replying to Ruddles:
By johngroganjga
22nd Feb 2023 20:45

Why would HMRC argue that dividends shown in accounts and appearing in the recipients’ tax returns were not dividends?

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Replying to johngroganjga:
By Ruddles
22nd Feb 2023 20:59

This has been discussed so many times that you really should know the answer to that. Have a look at CTM15205

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Replying to Ruddles:
By johngroganjga
22nd Feb 2023 21:19

This bit of CTM15205?

“The question whether a dividend is unlawful or not is not a tax issue. It is rather the application of company law to the particular facts, and the tax consequences flow from those facts. This is a matter in the first case to be determined by the company, and particularly in appropriate cases the company secretary who has a legal duty to ensure that the company acts lawfully, and so it will normally be the company or its advisers who first raise the point. Officers should not in general seek out cases in which it might be argued that dividends that have been paid are unlawful”.

Doesn’t this confirm what I said. That it’s none of HMRC’s business whether a dividend should have been in accounts and on tax returns in the first place?

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Replying to johngroganjga:
By Ruddles
22nd Feb 2023 21:25

No. Read on.

It is correct that it is not HMRC’s place to determine whether or not a dividend is unlawful. But if it is, they have their views on how it should be treated for tax purposes.

As I said earlier, one might disagree with those views but that does not avoid the possibility of having to argue with HMRC.

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Replying to Ruddles:
RLI
By lionofludesch
23rd Feb 2023 16:20

Ruddles wrote:

No. Read on.

It is correct that it is not HMRC’s place to determine whether or not a dividend is unlawful. But if it is, they have their views on how it should be treated for tax purposes.

As I said earlier, one might disagree with those views but that does not avoid the possibility of having to argue with HMRC.

And what are those views ?

In the instant case, the bank payments are marked as dividends, which suggests (maybe more than suggests) a contemporaneous intention that they should be dividends.

The disadvantage of unlawful dividends is that they may need to be repaid in the event of a winding-up. In that case, good luck getting your dividend tax back.

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Replying to lionofludesch:
By Ruddles
23rd Feb 2023 17:00

lionofludesch wrote:

And what are those views ?

Clearly set out in the guidance referred to.

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By legerman
23rd Feb 2023 16:43

Thanks all, much appreciated

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By Bagas.Ynnya
28th Feb 2023 16:41

To potentially save you looking up the HMRC guidance, this is the pertinent paragraph in CTM15205 -
"Where a dividend is paid and it is unlawful in whole or in part and the recipient knew or had reasonable grounds to believe that it was unlawful then that shareholder holds the dividend (or part) as constructive trustee in accordance with the principles stated by Dillon L J in Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] 1 Ch at page 457. Such a dividend (or part) is void for the purposes of both the Income Tax charge on distributions under ITTOIA05/S383 and the long abolished ACT charge under ICTA88/S14. The company has not made a distribution as a matter of company law, and so the dividend does not form part of the recipient’s income for tax purposes. The company has not parted with title to the sum that it purported to distribute, which as a consequence remains part of its assets under a constructive trust (see also Ridge Securities Ltd v CIR (1964) 44TC373). Where the company concerned is a close company, it is regarded as having made a loan to the shareholder by virtue of CTA10/S455(1), thereby triggering a charge under CTA10/S455(2). Relief would however be available under CTA10/S458 where the dividend is repaid to the company. That repayment might be by cash or cheque, or by a suitable entry in the loan account."

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