If your company accounts show that yourself and/or fellow director shareholders received more dividends than permitted by company law, this will have tax consequences. What’s the most tax efficient way to manage them?
What Are Unlawful Dividends?
The last couple of years have been tough for many businesses, which has resulted in significant reductions in profits. The impact of this is becoming more apparent as companies prepare their annual accounts. The lower profits are bad enough, but some director shareholders who take most of their income as dividends face an additional problem. If dividends paid exceed a company’s profits (current plus brought forward) they are deemed unlawful dividends. That is to say, they are not permitted by company law.
How Do Unlawful Dividends Get Repaid?
A shareholder who receives an unlawful dividend must repay it, or the part of it which is not covered by profits. In other words, it is a de facto loan.
In the past, HMRC often argued that rather than unlawful dividends being a loan they were earnings (in effect salary). HMRC liked taking this view as it produced a greater tax haul. However, these days it accepts that unlawful dividends create a loan.
Once the total amount of dividends paid unlawfully has been worked out, it must be attributed to each shareholder in proportion to their shareholding and recorded as a loan to them in the company’s records.
What Happens If Shareholders Don’t Pay Back This Loan?
There are certain instances whereby a company can be faced with a tax bill equal to 33.75% of the unrepaid loan. This applies if all of the following conditions are true: