Dividends: What you need to know as a director of a limited company

Here are some common questions and answers that will help you understand dividends better. You should also look for more information from other sources or speak to us (or your accountant if you have one) for advice when you need it. This guide is for directors of small and medium entities (SMEs). Bigger companies have different and more complicated issues (and there are special rules for public companies, insurance companies and investment companies).

How can you pay your shareholders?

There are different ways you can pay your shareholders, not just dividends. For example, you can also give them gifts or loans at a lower interest rate than usual. These are called distributions. A distribution is any payment or benefit that you give to a shareholder (or someone related to them) because they are a shareholder (or related to one). If you are a director and a shareholder, you can also pay yourself through salary or wages (as a director or employee) or borrow money from the company through a director’s loan account, or do both. The rules on distributions apply to what you actually do, not what you call it in the papers. So you have to know what kind of payment you are making and what it means for you and the company. You should also write down any decision you make(for example, in the minutes of a meeting or a resolution) to show what kind of payment it is. You should write the minutes after the meeting, but they should reflect what you decided at the meeting. You should not date the papers earlier than you made them, because that could be fraud. See below for more information on how to pay dividends.

Why are dividends different from other payments?

A dividend is a part of the company’s profits after tax that you share with the shareholders. You have to pay it to all shareholders (of the same type of share) according to how many shares they have and what the company’s rules (articles) say. The rules on dividends also apply to coupons, which are payments on some special shares called preference shares. You can only pay dividends from profits that you can legally use for this purpose, following the company law rules and procedures. If you pay dividends illegally, you could be personally liable for the amount you paid. Also, shareholders have to return illegal dividends they received, if they knew the facts that made them illegal (even if they did not know they were illegal). If you are a shareholder and a director, you have to consider what you knew in both roles in this situation.

How do you know if you have "available" profits to pay dividends?

The usual way to check if you have profits to pay dividends is to look at your last annual accounts that you sent to the shareholders. The balance sheet in those accounts will usually show“retained earnings” or “profit and loss reserves”. But for very small companies, the balance sheet will just show a number for “capital and reserves”. You have to figure out how much of those reserves are profits that you can use to pay dividends. By law, these are profits that pass a test of being “realised profits”. Profits from normal business activities are usually(but not always) realised profits. The accounts may not show the difference between profit reserves that are realised or unrealised. For example, some companies have transactions that change the reserves that are unrealised (such as changes in the value of properties or some transactions within the group).You have to be careful to make sure you only pay dividends from realised profits.

What if the company is doing worse than the last finalised set of accounts indicate?

Directors have to check if the company is doing worse than at the date of the last finalised accounts, to see if they have profits to pay dividends. If the profits in those accounts have gone down because of losses after the accounts date, then they can’t pay dividends from those profits by that amount. The longer the time between the accounts date and the planned dividend payment, the higher this risk may be.

What if the company is doing better than at the date of the last finalised accounts?

Directors may think that the company is doing better since the date of the last finalised accounts, so more profits available for distribution as dividends. In this case, they should make new accounts (called “interim accounts”) to see how much profits they have available. Interim accounts should follow the same rules that are used for seeing how much profits they can use for dividends.

For example, if the directors want to use management accounts for this, they will need to add tax on profits to the relevant date and think about other changes that might be needed in official accounts but that have not been done in management accounts, such as impairments.

Is it a good idea to pay dividends at all, even if the company has profits to do so?

Even if the company has profits that can be used for dividends under the legal tests, directors should think about the practical effects of paying dividends, including how it will affect the company’s cash flow.

For example, will the company have to repay loans that will need cash? If the company does not have cash saved, will it be able to borrow cash on fair terms and, more importantly, should it do so (to pay dividends)? Directors should think about whether the company will still be able to pay its debts after a proposed dividend or other payment.

This means thinking about the immediate cash effects of a dividend and the future ability of the company to pay its debts when they are due. Directors of a company in financial trouble should think about getting suitable professional advice.

What if the company is part of a group?

The main thing about groups of companies is that profits that can be used for dividends are calculated for each company separately and based on the accounts for that company. If a company has losses, it can’t pay dividends even if the group (including its own subsidiaries) is making money. Transactions within the group are common in groups of companies.

For example, one company may transfer a property to another at cost (less than market value), sell tax losses for a price that is not fair or leave the price as a loan within the group. Transactions at less than market value need careful thinking by the companies involved, and this is an area where professional help is a good idea.

How to actually pay dividends?

Before paying dividends, directors should consider and confirm the following things:

· the dividends are based on the profits shown in the latest accounts or reports that the shareholders have seen, and that the balance of this realised profits cover intended dividends;

· the profits have not gone down since then;

· the company can still pay its bills on time after paying the dividends;

· if the company has an auditor, they need to follow the rules that apply when the auditor’s report is not clear.

The company’s articles of association are the rules that tell how the company should run. They usually include the steps for paying dividends (for example, see article 30 of the UK’s model articles for private companies limited by shares). The articles usually say that:

· the directors should propose a dividend amount;

· the shareholders should vote to approve the dividend amount (for example, by voting at an annual meeting or by signing a written resolution);

· the shareholders cannot vote to pay more than what the directors proposed. The articles also usually say that the directors can pay dividends whenever they want during the year. These are called“interim” dividends. The company needs to follow the rules for legal dividends from the start until the end of the process.

The dividend becomes a legal obligation for the company when:

· the shareholders agree to a final dividend (even if it is paid later); or

·  the directors pay an interim dividend.

The company should keep good records of the payments, such as evidence that the dividend was based on the right accounts or reports and minutes of the directors’ or shareholders’ meetings. The company also needs to follow the tax rules and give the shareholder (or the bank or building society if the dividend is paid into their account) a certificate that shows the dividend amount and the payment date.