Overpaid dividends - what will the Taxman say?
Company cash
If your company has cash in the bank, it’s reasonable to think that the director-shareholders have the right to draw this as dividends. That’s not the case. Company law only allows dividends to be paid out of profit, and money in the bank doesn’t necessarily mean there is one. It might, for example, be there to meet suppliers’ bills that are yet to arrive.
Vulnerable companies
If you’re an established company with a large pot of undrawn profit built up over the years, you won’t usually have to worry about dividend levels. But if yours is a newish company, or one where the tough trading conditions mean you don’t have a lot of profits to play with, you’ll need to keep a close eye on levels if you want to pay dividends.
Tip. Get your bookkeeper to prepare monthly or quarterly management accounts to help you keep track of profits.
Overpaid dividends
It’s easy to overstep the mark, especially if you’re drawing dividends on a frequent basis, e.g. monthly or quarterly. Excessive dividends are said to be “ultra vires”; this means they are beyond your powers as a director-shareholder to pay. But usually you see them referred to as “illegal” or “unlawful” dividends.
Trap. Company law says a shareholder who receives an illegal dividend must pay back the excess amount to the company. There is an exception, but this usually only applies to minority shareholders (see The next step).
Tax consequences of illegal dividends
Naturally you can only repay an illegal dividend once you’ve discovered it exists. This usually happens when your accountant prepares the annual accounts. In the meantime the excess dividend counts as a loan to you from the company.
Trap. Unless you repay the “loan” within nine months of the end of your company’s accounting year it will have to pay tax equal to 25% of the amount outstanding. HMRC will repay this tax after you’ve cleared the debt. But there’s potentially another tax bill that can’t be avoided, even where you repay the loan.
Beneficial loans
Where a loan to a director-shareholder exceeds £5,000 at any time during a tax year for whatever reason, it counts as a benefit in kind (BiK) on which the director must pay tax, and the company Class 1A NI. The BiK is relatively small, but if you discover its existence only after it was due to be declared to HMRC on Form P11D, i.e. by July 6 after the end of the tax year, your company could be charged a penalty.
Tip. The BiK can be retrospectively cancelled where a director-shareholder pays interest equal to at least 4% of the average loan balance. Not only will the tax and NI charges be avoided, but the risk of a penalty is negated. There are conditions to using this get-out-of-jail procedure,but these are easy to cope with (see The next step).
For details of the exception (CD 14.20.05A) and the procedure (CD 14.20.05B), visit http://tipsandadvice-companydirector.co.uk/download.
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