Illegal dividends and taking dividends from your company -refer ctm15205

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Introduction

What are illegal dividends (HMRC) or unlawful dividends and how do these arise when you are UK contracting? Let’s take the time to consider when an illegal dividend or illegal distribution may occur when you are paying dividends from a limited company. In addition, let’s consider what you should think about when you’re taking dividends from your company. In this guide, we’ll cover how to take dividends from your private limited company and research can I take dividends from previous years profits. We’ll also consider what is an illegal dividend and find out the guidance in CTM15205 fits in with this. Basically, CTM15205 is HM Revenue & Customs (HMRC) official guidance in this area.

Another term which we can use to describe illegal or contractor unlawful dividends is `ultra vires dividends.’ This in turn is a Latin phrase which mean `beyond the powers.’ It’s used in law to describe an act which requires legal authority but is carried out without it. Therefore, it exceeds the scope of power given to them by current laws.

When you’re contracting and you run your own company, as a director and shareholder, you’ll usually draw down profits from time to time. Basically, as part of profit extraction from your company, you may pay yourself a dividend from your business. On the other hand, you may receive your income in the form of a salary. It’s key to note that ltd company dividends are subject to tax but not National Insurance, unlike salaries. However, if you work through your own UK contractor limited company, a mix of salary and contractor dividends may be the best choice when you consider how to be tax-efficient.

Initial thoughts 

First thoughts

As a UK contractor, when you run your own company, you may wonder how much can you pay yourself in dividends. The answer regarding how much dividends can I take in terms of profit extraction is there’s no limit in terms of taking dividends from your company. That’s on the assumption your company has enough profits available to pay the private company dividends which you plan to take out.

Therefore, as time moves forward, your business can go ahead paying yourself dividends (UK) now and again. The UK dividends are payable to the shareholders of the company. Moreover, the UK company dividends are usually payable to the shareholders in line with their share ratios.

Common questions

As a new or experienced UK contractor or limited company owner, you may have questions about paying yourself company dividends. Therefore, these could include:

  • How do dividends work in a limited company?
  • When can you take dividends?
  • How often can you take dividends?
  • How often can I take dividends from my company (UK)?
  • What are dividends in business?
  • How often can you pay dividends?
  • How to pay yourself dividends (UK)?
  • When can I take dividends out of my company?
  • How to take dividends from your company?
  • When can you pay yourself dividends?
  • How much dividends can a director take?
  • How to take dividends from a limited company?
  • Are dividends paid after Corporation Tax?
  • Can you pay dividends if you make loss?
  • What is a dividend voucher?

In this guide, we’ll consider all of the above. What’s more, we’ll look at what to do when you pay some company dividends which may be turn out to be illegal.

Initial thoughts on Illegal dividends (HMRC) 

Pay director dividends from post-tax realised profits 

Private companies make dividend payments to their shareholders. What’s more, they pay these from company’s post-tax realised profits. This means your company’s profit for the year after you deduct Corporation Tax. You may ask can I take dividends from previous year’s profits and the answer is yes. Therefore, when considering limited company dividends, contractor available profits will include retained profits or losses brought forward from the previous set of annual accounts. Adding this together shows the total that’s available which you can pay as disbursements now. To summarise, the accumulated realised profits (or accumulated realised losses) plus the current year’s profit or loss, after allowing for any tax due, is the distributable profit that’s available as UK dividends, so far as the company has the cash to do so.

When your limited company is paying yourself a dividend and it’s more than the sum of post-tax profits and any P&L balance brought forward from the previous year, we call this an illegal dividend or illegal distribution. Therefore, it’s essential to check profit levels to ensure there’s enough funds before taking dividends from your company. If you’ve insufficient profits, you’ll have to wait until you generate more income before you can pay dividends.

The current rules about the payment of dividends are set out in Section 830 of the Companies Act 2006. This states, “a dividend or distribution to shareholders may only be made out of profits available for the purpose”.

If you ever find yourself in a position where your company can’t pay its taxes, this could be because you have paid too much in dividends. As a result, there’ll have been contractor illegal dividends. Consequently, if you can’t see yourself meeting your company’s tax liabilities, there’s certain things that you’ll have to consider in this case.

Other guides

Before we move on, there’s several aspects to consider regarding how to pay yourself in dividends. Therefore, when you’re a UK contractor taking dividends from a company, besides making sure you don’t draw an illegal dividend, these additional aspects include:

  • How much dividend can I pay?                                                                                                                              
  • Illegal dividends (this guide).

Taking dividends from your company and when they become illegal

When should I pay private company dividends? 

You may ask how often can I take dividends from my company (UK)? There’s no right time as such with regards to your business paying company dividends to you. You can draw these whenever and how often you choose, providing there’s sufficient profit. Most limited company contractors will be drawing dividends from their business once per month or perhaps once a quarter.

When you’ve your own business, what paperwork or documents should a company paying dividends complete? Basically, in terms of paperwork for UK company dividends, technically, you can create a dividend voucher. What’s more, you can do this each time you declare a dividend. You may wonder what are dividend vouchers and to explain, this is an official document which shows the details of the dividend payment and is signed by a director of the company.

You can file the dividend tax voucher with your personal tax records. The voucher will then be available to show to third parties should the need arise in the future. As a contractor, you’ll usually declare and pay the dividend at the same time.

In real life, a third party isn’t likely ever to ask to see the dividends voucher. Therefore, you or your contractor accountant can prepare minutes of meetings at your company year-end. These will approve the limited company dividends that you pay during the financial period. If you require dividend vouchers in the future, you can draw these up then.

Illegal dividends (HMRC) -when you draw too much 

In most scenarios, when you’re taking dividends from your company, this is a simple process to perform. However, you may, by accident, on occasion take too much private company dividends. As a result, some of these will therefore be unlawful dividends.

When you take more business dividends than are available in profit, the business’s financial position will show an overall loss. This loss is then, in effect, due to your contractor’s unlawful dividends. Therefore, you’ll be liable to repay the amount of unlawful distributions in the future.

The unlawful dividends Companies Act 2006 makes provisions for illegal or unlawful dividends. Indeed, the Companies House Act 2006 states, “a dividend or distribution to shareholders may only be made out of profits available for the purpose”. Ross Martin have another good guide on this area and how the Companies Act 2006 relates to this.

Can I take dividends from previous years profits?

When you’re trading you may make an overall loss one year or another for a variety of reasons. In this case, can you take dividends if you make a loss? When your company has some previous year’s profits that are still on the Balance Sheet and these exceed this year’s losses, the balance can be paid as company dividends in the future. However, as is always the case, it will depend on when the business has these funds as liquid cash i.e., so far as the funds aren’t tied up in company assets such as fixed assets (car, computer equipment, etc) or investments.

It’s key to highlight that you only pay tax on company profits. What’s more, they’re taxed in the year that the business generates these profits. Therefore, all of the company funds which haven’t been paid out as expenses, salaries, or distributed as dividends will be distributable in the future.

The formula you can use to avoid drawing too much dividends 

A limited company can prepare some management accounts or interim accounts to see the business’s current financial position. However, there’s a quick and easy way to work out how much you can draw before you take a dividend from your company. Therefore, we show this in the formula below.

The actual formula

The formula to use when paying yourself dividends from your company and calculating the maximum profit extraction is as follows:

Then, add together all of your business expenses and gross salary in the current accounting year.

Step 1 Take the sales in the current accounting year.
Step 2 Column 2 Value 2
Step 3 Next, take your expenses and gross salary in 2) above. Then, deduct these from the sales total in 1) above to arrive at a profit before Corporation (CT).
Step 4 Then, deduct CT from the profit figure in 3) above to arrive at a profit after CT. The CT will be at 19% or 25%, depending on whether your company is small or large (see our Corporation Tax guide for details).
Step 5 The final step, take the profit that is brought forward from the previous accounting year (as shown in the Profit and Loss account figure at the bottom of the Balance Sheet). Add this to the profit after tax figure in 4) above.

Result 

After step 5) above, the total that you’ll arrive at is the distributable reserves currently in your business. This is the amount from which it can pay as UK company dividends. This is providing it’s the funds to do this i.e., some funds aren’t tied up in other assets as mentioned earlier.

Alternative method 

Instead of the above, you can look at the company’s assets that are of a liquid nature, such as the bank account.

The next step is to deduct from this any company taxes that are due up to the present day in time. This will include any VAT yet to pay, any PAYE/NIC that’s due and any Corporation Tax on your company’s profit up to the present day. You’ll also deduct any other creditors at this point in time. Once you deduct these, it’ll leave the amount of cash in your business available that you can pay as business dividends. 

Further things to consider in respect of Illegal dividends 

What should you do when you realise you’ve taken unlawful dividends? 

If your company makes an illegal distribution, it’s probably the case that you may have just been taking a look at your business bank balance. Therefore, you may have forgotten to consider the business’s total bills and any monies your company owes. What’s more, if you do draw unlawful dividends, it’s not a criminal offence. Nor will you receive any fines for this. Instead, it’s a case that you didn’t take enough care. As a result, you’ll now have to look into rectifying an unlawful dividend.

Your accountant will prepare your annual business accounts at the end of your financial year. At this point, it’ll become clear if your business’s financial position is in the red due to unlawful dividends. If the business is in the red, you may find that your company may have paid too much director dividends. As a result, the overpaid dividend amount will be put to your director’s loan account and this’ll then need repaying to the company. When the reason for the company being in the red is down to taking too much UK dividends and this overdrawing becoming a loan instead, you should aim to get any amount you owe repaid as possible.

Therefore, if you’ve paid too much company director dividends, and providing it was an interim dividend, the easiest way you can rectify this is to repay the money you owe to your company as soon as you discover it. If you can’t currently do this, you can wait to see if future sales will generate enough income to create a profit again. Then, you can declare a dividend but don’t draw it from the company and instead the dividend will be credited against the director’s loan account amount that you owe due to the illegal dividend.

Contractor’s illegal dividends -director’s duties 

As a company owner, it’s essential to take note that it’s one of your director’s duties to check what you can take as limited company dividends. You can use the formula above to check the company’s post-tax profits at any time. The overall profits which are available for company dividends are after you take into account the Profit and Loss account balance brought forward.

If the business does pay too much UK dividends in the year-end accounts, you’ll not go to jail for it. In the event that this occurs, you can do a dividend reversal and convert those director dividends into a director’s loan instead as explained earlier. After doing this, you’ll have to repay the director’s loan to the company at a future date. The sooner that you repay this, the better it’ll be.

Therefore, as a director, you can check your business profit levels. You can do this before you pay any company dividends from your business. If you can’t pay any dividends, you should wait until your business generates more profits. You can then recheck this position at a later date.

Tax office guidance and tax on overdrawn director loan accounts 

HMRC guidance -illegal dividends 

The tax office has further guidance for the above. You can find this in Manual CTM20090. You can also find more info on this in Manual CTM15205.

Section 455 Tax 

Your accountant will prepare your accounts when your company year-end comes around. At this point, you’ll know if your business has paid you too much dividends. If it has, your accountant will have to do a dividend reversal. As a result, a reduced credit or overdrawn director’s loan account shows in the company’s accounts instead.

As we mention above, it’s best to repay any director’s loan account as soon as possible. Ideally, you should repay this within nine months of your company year-end. If you repay this after nine months, the business must pay Section 455 Tax. This tax is 33.75% of any overdrawn balance. Indeed, 33.75% is the same as the higher personal tax rate on dividends. Section 455 Tax is a temporary tax, which is repayable to the company after you repay the director loan. Please take note that although HMRC will refund the tax in the future, it’s a temporary hit on your cash flow.

We explain Section 455 Tax and overdrawn director loans in more detail in one of our other guides which covers a loan to a director.

Final thoughts on illegal dividends 

We have considered in this guide what is an illegal dividend and how this may arise. Indeed, when you’re taking dividends from your company, it’s not uncommon for the unlawful dividends position to occur. Besides, many UK contractors who experience this won’t happen to notice when an illegal dividend occurs. That is until their accountant brings it up for them. Therefore, it’s important to ensure you don’t draw any illegal dividends, as we highlight in this guide.

When you work out what you can draw from your business, it’s important to remember the answer to the question can I take dividends from previous years profits. If you’ve existing profits or losses brought forward in your company from the previous year, your company’s total realised profits or losses brought forward should be taken into account along with the current year’s post-tax profits, in terms of what is available for profit extraction and therefore what you can draw.

When you run your own company, it’s a good idea to keep your company’s tax savings in a separate account. Therefore, you could put these into a company savings account. This is good advice and best practice for a UK limited company contractor. This way, the company’s tax savings are kept away from the regular funds in the Current account. When tax payments become due, you can make transfers back to the Current account and make the payments to the tax offices. Therefore, if you always aim to keep your company tax savings in a separate company account, this’ll help make sure that you don’t spend them.

Link to Contractor Advice UK group on

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Published On: January 4th, 2024 / Categories: Dividends /

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