Illegal dividends – what they are and how to avoid them

Dividends are usually a great, tax efficient way of withdrawing money from a company by the owners.  A company can declare a dividend if it has sufficient profits available within the business.

However, there are certain rules that will dictate when a dividend can be paid by the company.  Not least, is having sufficient profits in the company after taking into account liabilities and tax payments.

Unfortunately, some business owners tend to take a view that whatever cash is in the bank can be simply taken as a dividend without taking into account future payments.  If this happens it can lead to what is known as ‘illegal dividends’

What happens if illegal dividends are taken

Although illegal dividends are not a criminal offence, business owners have to take reasonable care when paying a dividend to ensure profits are checked and are available for the dividend to be declared.

If an illegal dividend has been paid, the easiest way to rectify it is to repay the money back to the company. Alternatively, if you expect the company will be generating income in the future, there is the option to wait and not take any further dividends until a profitable position has once again been reached.

Should business owners continue to pay illegal dividends, the company could be forced to pay income tax and national insurance contributions as it could be reclassified as salary.  Alternatively, if the illegal dividend is not repaid, it may be treated as a director’s loan which would attract S455 tax at 32.5% plus a potential charge for benefit in kind on the interest.

Posted by Beth Hogg