Dividends: When it goes wrongby
Steve Collings explores how practitioners can advise on dividend extraction as part of tax planning strategies.
In practice there are two types of dividend:
- An interim dividend which is paid during the year and is usually declared by the directors; and
- A final dividend which is usually paid once a year, is recommended by the directors and is approved by the shareholders.
A point worthy of note is that the Companies Act 2006, s830 states that distributions are lawful if they are paid out of accumulated realised profits less accumulated realised losses. TECH 02/17BL Guidance on Realised and Distributable Profits Under the Companies Act 2006, para 3.9 provides further detail on when a profit is realised.
This article examines a case heard in the High Court and Court of Appeal where dividends were eventually found to be unlawful following a liquidation.
Under FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland care needs to be taken to ensure a record is kept of reserves which are distributable and reserves which are not. For example, under FRS 102, fair value gains on investment property are non-distributable profits because they are not readily convertible into cash, hence the gain is not realised profit for distribution purposes. The gain would only become a realised profit once the property has been sold. If a dividend were to be paid out of non-distributable profit, the dividend would be unlawful.
The treatment of non-distributable profit for UK GAAP reporters is not consistent across all reporting entities. Some entities ring-fence non-distributable profits into a separate component of equity, whereas other do not. There is nothing in company law which requires a separate component of equity to be created to take non-distributable profits. However, it is an efficient mechanism to have to keep a track of those profits which are distributable and those which are not. For entities which do not ring-fence non-distributable profits within a separate component of equity, a separate record will need to be maintained to ensure that no dividends are paid out of non-distributable profit.
Global Corporate v Hale 2019
The issue of dividends was the catalyst in the case of Global Corporate v Hale 2019. This case surrounds the issue of unlawful dividends.
Mr Dirk Hale was a director and shareholder of Powerstation UK Limited. This company had been in financial difficulty since 2008 before it eventually went into liquidation in 2015.
Mr Hale was one of two shareholders and was paid a small salary to cover his national insurance contributions and interim dividends which supplemented his remuneration. At the end of each financial year, the company’s profits would be assessed by the accountant. If there were insufficient profits from which dividends could be declared in accordance with s830 of Companies Act 2006, the accountant would re-characterise the payments so that they were salary. Additional PAYE and NIC would then be paid to HMRC.
The liquidation completed in November 2015 and the liquidators concluded that the company had insufficient distributable reserves from which the dividends could be paid. This led the liquidator to concluding that the dividends had been paid in contravention of s830, Companies Act 2006. Mr Hale refused to repay the dividends and the Appellant, Global Corporate Ltd, took the matter to court claiming the dividends paid to Mr Hale were unlawful.
The High Court ruled that Powerstation UK Ltd had not declared and paid dividends each month, despite the fact that the payments had been recorded as an interim dividend and tax vouchers had been drawn up. The High Court judge concluded that the director had taken a decision to declare and pay a dividend and that this decision would be reviewed at the end of each financial year by the accountant. Mr Hale had received advice from his accountant and therefore Hale claimed he did not know, nor intended to be in breach of, s830 of Companies Act 2006.
As these payments were not dividends, the provisions in s847 of Companies Act 2006 Consequences of unlawful distribution could not apply. The High Court also held that there was no misfeasance because even if Hale had an obligation to repay the money, he had an equal claim as quantum meruit (the ‘amount he deserves’ under law) for services rendered to the company. In other words, Hale had provided a service to Powerstation UK Ltd, and he was entitled to be remunerated for his services. If Hale had not been remunerated, then somebody else would have been.
The case was then subsequently heard in the Court of Appeal who disagreed with the High Court’s judgement.
The Court of Appeal held that the payments were, in fact, dividends and fell within the scope of s830 of Companies Act 2006. They cited three reasons for their conclusion:
- From a review of the available evidence, the payments were intended to be treated as dividends. This was clear from the fact that they were described as ‘interim dividends’ by the directors and were structured as dividends for tax purposes.
- The High Court had wrongly focussed on Hale’s intention when authorising monthly payments to himself as dividends. Instead, consideration should have been given as to whether the payments were lawful distributions of the company’s assets. The fact that the accountant could reclassify the nature of the payments did not stop them from being dividends at the time of payment.
- There was no such contract for remuneration in place and hence the conclusion that quantum meruit could act as an offset or defence against the claim by the company was wrong. In reaffirming the House of Lords case of Guinness PLC v Saunders, (in which the House of Lords held that the law would not imply a contract for remuneration when such a contract could only be agreed under the articles of association by an appropriate resolution of the board), the Court of Appeal held that for such a defence to be available, a contract for remuneration would need to be in place. Perhaps more importantly was the fact that the company was also in liquidation, and this would mean that any quantum meruit claim would be an unsecured claim requiring proof of debt in the liquidation.
The above case highlights the importance of considering whether there is sufficient distributable profit in which to declare a dividend as well as the impact that the payment of the dividend will have on the financial position of the entity. In Powerstation UK’s case, the financial statements for the year ended 30 April 2014 showed it did not have any distributable profit available from which to declare the dividends and hence they were paid unlawfully.
What this case highlighted was that the legality of a payment to a director is tested at the time it is made. Where it is subsequently discovered that the dividend is unlawful, it cannot then be re-characterised.