What Are Illegal Dividends and How They Can Cost Your Business Big

An illegal dividend occurs when a company distributes profits in violation of legal requirements set out by the Companies Act 2006 or common law. In simple terms, it's a distribution that shouldn't happen because the company doesn't have enough profits, or the correct procedures weren't followed. Let's break down some common scenarios where illegal dividends might occur:

Common Examples of Illegal Dividends:

• Paying Dividends When Profits Are Insufficient: Distributing dividends without having enough profits to cover the payment.

• Skipping Proper Administrative Procedures: Failing to follow legal steps or board approval processes for dividend distributions.

• Not Referring to the Correct Accounts: Issuing dividends without accurately reviewing the financial statements.

• Miscalculating Profits: Incorrectly calculating the available profits for distribution.

• Unequal Dividends for Shareholders of the Same Class: Paying different amounts to shareholders who hold the same class of shares.

The Risks of Illegal Dividends: Consequences for Shareholders, Directors, and the Company

The repercussions of illegal dividends can be severe for all involved parties:

1. Shareholders
   Shareholders who receive illegal dividends may be forced to repay them if they were aware, or should have been aware, that the company couldn’t afford it.

2. Directors
   Directors are personally liable for any illegal dividends issued by the company, including those they themselves receive.

3. The Company
   The company risks being deemed insolvent, which can damage its reputation and hinder its ability to secure loans or credit. Additionally, it may face higher tax rates on payments made to shareholders.

4. HMRC
   If the tax authority discovers illegal dividend payments, they may launch an investigation and impose penalties.

How to Avoid Illegal Dividends: Protect Your Company and Avoid Costly Mistakes

To minimize the risk of issuing illegal dividends, directors must confirm that sufficient distributable profits are available before making any payments to shareholders. In the event of an illegal distribution, it’s crucial to seek professional advice to understand how to rectify the situation and potentially mitigate tax liabilities.

Key Takeaways:

• Understand the legalities behind dividend distribution to avoid costly errors.

• Ensure your company has enough distributable profits before issuing dividends.

• Seek professional advice if you suspect an illegal dividend has been issued. 

By following the proper procedures, you can protect your business, your shareholders, and your reputation from the significant risks of illegal dividends.

Concerned About Illegal Dividends? Book a Meeting with Our Tax Experts Today!

If you're unsure whether your dividend distributions are compliant, don't risk costly consequences. Schedule a consultation with our tax experts to review your situation and ensure you're on the right track. Book your meeting now to protect your business!