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Unlawful dividends

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Dividend paid by client (OMB) when there was cash available but no reserves. I believe that the dividend is repayable and should be accounted for as a debtor in the accounts, but please feel free to disagree. The amount due is subject to tax under s455 as you might expect. 

Although the dividend is unlawful, in my view it is still a dividend in which case the shareholder/director is still taxable once dividends exceed £2,000. Result is that until it is repaid to the company there is tax due from the company under s455 as well as tax from the shareholder on the dividend. 

I must have been lucky as I hadn't had a problem with clients paying unlawful dividends since dividends became taxable at the basic rate, but am I missing anything?

It's yet another reason to listen when we keep saying that you cannot just pay yourself a dividend when you feel like it but you need to do the background work.

 

Replies (21)

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By SteLacca
16th Sep 2019 11:31

It's not unlawful if, at the time the dividend was declared, the director could reasonably believe that there were sufficient reserves. It's not clear from your question if there would have been a reasonable belief, but certainly if there was cash available he/she may have so believed.

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RLI
By lionofludesch
16th Sep 2019 12:42

The dividend isn't necessarily chargeable under s455. How much was outstanding from the director at the year end and how much was repaid within the ensuing nine months ?

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By thomas34
16th Sep 2019 13:15

I can see your logic (I think) but your proposed entries would involve some double counting. If you decide to create a debtor the other half of the entry would be to credit dividends and reduce the resulting dividend tax.

Personally I treat dividends as such even if I suspect they were unlawful at the time they were paid. If HMRC decided to reclassify as a loan (and I wouldn't fight that) the dividends self-assessed on the shareholder's return would be reduced.

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By johngroganjga
16th Sep 2019 15:46

It’s for the company, not you, to decide whether the payment should be refunded. Only if they do should you reclassify it as a debtor, with S455 consequences of course. If it is a debtor, it is obviously not a dividend as well!

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Replying to johngroganjga:
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By paul.benny
17th Sep 2019 09:40

Good point.

The OP can point out the issue to their client and make recommendation but it's for the directors to recommend and shareholders to approve dividends.

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By marks
16th Sep 2019 23:31

My view is if a dividend is declared then it is still a dividend irrespective if there is reserves or not to cover it.

If the reserves arent sufficient to make the dividend legal then it is still a dividend. Just an illegal one.

Only really an issue if the company is wound up and there are debts that cant be paid by the company then the liquidator may request the shareholders to repay any dividends declared illegally.

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Replying to marks:
RLI
By lionofludesch
17th Sep 2019 09:12

Definitely not an illegal dividend.

Maybe unlawful.

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Replying to lionofludesch:
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By Peter Bromiley
18th Sep 2019 10:38

They are known as illegal dividends, though. The ACCA call them that.

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By JCresswellTax
17th Sep 2019 09:15

Its either a dividend or a loan so is either charged to personal tax or S455. It cannot be both!

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Replying to JCresswellTax:
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By Tax Dragon
17th Sep 2019 10:30

Forgive my ignorance, but is there a third option?

Some, but not all, unlawful dividends must be repaid, or so I believe. I further understand that a shareholder who is not obliged to repay the amount may nevertheless choose to do so to regularise the situation. In such a case, there's a repayment without there having been a debt.

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By Justin Bryant
17th Sep 2019 16:40

If you search this forum you will see that it is arguable the recipient holds the funds as constructive trustee for the company (so no s455 etc. issues).

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By Ian Bee
17th Sep 2019 17:37

Thanks for all the useful comments on this post. I should have dug deeper in the first place as it is covered by HMRC manuals CTM 15205.

Going back to the question, the same person is the sole director and shareholder. Distributable reserves were minimal at the beginning of the year, and the dividend was higher than the amount of realised profits at the time of payment which was in cash. The client should have been well aware of this as I have told them often enough before but maybe they forgot as they had been profitable for the last couple of years.

CTM 15205 does state that where the recipient should have known that it was illegal, the dividend is repayable but is also void as regards income tax.

Where the company is a close company the amount paid represents a loan to the participator with a potential charge to tax under s455(2) until it is repaid.

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Replying to Ian Bee:
Psycho
By Wilson Philips
17th Sep 2019 21:19

Duplicate post

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Replying to Ian Bee:
Psycho
By Wilson Philips
17th Sep 2019 20:36

Bear in mind that is HMRC’s interpretation, which isn’t necessarily correct. But if it is correct then Justin is wrong. On that basis I conclude that HMRC are likely to be correct.

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By Matrix
18th Sep 2019 06:46

Are there still no reserves today then or why would repaying the dividend cause a s455 issue?

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By pridgway
18th Sep 2019 10:13

The legislation talks about a loan or an advance. Therefore if the dividend is illegal it is held on constructive trust; however, there has still been an advance and so s455 is still applicable.

In general, the directors ought to know the financial situation of the company and where the shareholders are the directors of the company it is difficult to argue that they were not aware or ought not to have been reasonably aware of the situation.

In my opinion, both HMRC and Justin are right!

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Replying to pridgway:
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By Tax Dragon
18th Sep 2019 10:47

pridgway wrote:

In my opinion, both HMRC and Justin are right!

I had wondered, in my ignorance, whether that was a third option.

And your explanation is very interesting. My counter would be that, if you take the meaning of "advance" to be something like "any advance made on a future commitment or payment" (which, I think, is probably its ordinary meaning), then a repayable unlawful dividend would not of itself be such an advance.... or at least not necessarily. It could depend on why the dividend is repayable.

In the generic, I suspect Justin (and you) are right.

In the specific context of a director-owned company, I think it would be hard to argue with HMRC's line.

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7om
By Tom 7000
18th Sep 2019 11:07

Its not a dividend as its illegal
It goes to his loan account
S445 is payable ( or not if repaid or a div paid in a future period to cancel the loan - within 9 months)
No divs go in his personal tax return... its not a div.

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Replying to Tom 7000:
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By Tax Dragon
18th Sep 2019 11:26

Tom 7000 wrote:

Its not a dividend.

It's not a loan either.

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Replying to Tom 7000:
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By Ian Bee
18th Sep 2019 11:44

I agree. This is exactly how I see it. The dividend is not taxable in the hands of the shareholder, as recognised by HMRC.

If you go one step further, if the shareholder was not aware that the dividend was unlawful, and could not have been aware (eg if the company is a large PLC) the unlawful dividend IS a dividend with all the tax consequences that follow.

As others have said, there is no way you would want to argue that with a sole director/shareholder.

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Replying to Tom 7000:
By pridgway
18th Sep 2019 11:49

It may be a matter of semantics whether something is unlawful or illegal (unlawful is against the law, illegal is a very sick bird). But s847 Companies Act 2006 is "consequences of an unlawful distribution" which implies you can have a distribution (dividend) which is unlawful (illegal) otherwise there would be no consequence. The obligation is to repay which does not make it a loan. It is held on constructive trust and therefore does not form part of the income. S455 is payable because there has been an advance not a loan. Practically the result may be the same.

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