What is the situation when you want to take dividends from your company but there are not sufficient reserves to do so?
This can be a particular problem for start-up companies or established companies that experience a temporary fall in profits. If you do take dividends when the reserves are not sufficient to do so then HMRC will argue that this is beyond the director shareholder powers and will argue that it is illegal.
The consequences of an illegal dividend
Company law requires the shareholder to repay the dividends back to the company. On the other hand, HMRC will want to treat the dividend as salary and try and obtain additional tax through PAYE and National Insurance. However, you should strongly rebut this approach by HMRC as it is very unlikely the courts will try to arbitrarily recategorise dividends to salary. If there is a company record to indicate the payment was intended or structured as salary then it would appear HMRC have no special powers to treat illegal dividends as salary.
You should ensure the proper paperwork for dividends are produced to ensure you leave little room for HMRC to argue this point. However, please note HMRC may also treat the illegal dividends as a loan and if it isn’t repaid within 9 months of the company’s year end then the company will have to pay 32.5% tax on the loan. This will be refunded by HMRC when the loan has been repaid
It is always important before you take any action that you obtain professional advice. If you have any questions in respect of the above then please do not hesitate to contact our tax experts by sending an email to firstname.lastname@example.org.
Kevin Wright is a Chartered Accountant and Chartered Tax Adviser at KW Chartered Accountants. They are based in the West End and are highly recommended by their clients and introducers. http://kwaccounting.com/