The Dividend Payment Process: A Guide

Navigating the dividend payment landscape can be complicated, and it’s common for company directors to make mistakes without professional advice. Familiarise yourself with dividend legalities, the various types, how to declare them, whether or not your company can (or should) pay them, and much more, in our essential guide.

If you’re looking for help with paying dividends, book an appointment with one of our friendly accountants today, or carry on reading for further information. We also help companies with a wide range of responsibilities, from Year End Accounts to Payroll Management.

N.B. This guidance is intended for directors of small private companies, as more complicated matters may arise for larger companies (with special rules applicable to public companies, insurance companies, and investment companies).

What is a Dividend?

A dividend is a distribution of a company’s profits, after corporation tax, to its shareholders. Dividends are payable to all shareholders (of the same share class) in line with their shareholdings, and are regulated by a company’s Articles of Association and any shareholder agreement. Unless otherwise specified, the dividend payment process adheres to the guidelines outlined in paragraphs 30-31 of Table A. These rules also cover the coupons payable on preference shares.

Articles of Association

Articles of Association typically specify the following (including the model articles – bespoke articles can offer advantages, e.g., different share classes can have different dividends):

• The directors are responsible for recommending a dividend.
• A dividend must be declared through an ordinary resolution (a shareholder decision), such as a vote at an Annual General Meeting (AGM) or through a written resolution.
• Members are not allowed to vote for a dividend greater than the amount suggested by the directors.

These articles also usually grant the directors the authority to pay interim dividends at any time (see more on interim dividends under the heading “Dividend Types: How to Declare”).

The legality of a dividend must be assessed not only at the initial stages of the process but also up to the point when the dividend becomes a legally binding obligation for the company. This occurs when members declare a final dividend (even if it’s scheduled for a later date), or when an interim dividend is actually paid out.

Can Your Company Pay Dividends?

As outlined in the Companies Act 2006 (Section 830), it is stated that “a company may only make a distribution out of profits available for the purpose”. In practical terms, this means that a company must have sufficient profits to cover the dividend on the payment date – otherwise, the directors may have to pay the money back. See more on available profits, financial positions, and the treatment of improperly paid dividends further on in the guide.

Dividend Types: How to Declare

Before declaring dividends, a company’s directors must hold a board meeting and record the meeting’s proceedings (“board meeting minutes”), whether in paper or electronic format. These records should be stored alongside their statutory documents, as outlined in CA 2006 s388.

There are two main types of dividends: interim and final:

Interim Dividends

Interim dividends are paid at various intervals during the year, e.g.,  monthly, quarterly, or annually. Before declaring an interim dividend, the company’s directors must ensure that the company’s financial health justifies this payment, using profits available for distribution (see above).

Importantly, the general meeting doesn’t have the authority to intervene in the directors’ decision to pay interim dividends. It’s worth noting that HMRC considers the date when interim dividends are recorded in the company’s books as the taxable payment date.

Final Dividends

On the other hand, final dividends are paid once a year after the end of each accounting year. When a final dividend is declared, and the resolution specifies a later date for payment, it essentially creates a debt owed to the shareholder.

However, the shareholder cannot take any action to demand payment until the specified due date (or dates if paid in fixed instalments). In these cases, the “due and payable” date is the one set for payment, not the declaration date.

Dividend Vouchers

or building society if it’s being paid into a bank account or building society account). The dividend voucher should contain the following details:

• Company’s name and registration number
• Dividend issue date
• Name and address of the shareholder in receipt of the dividend
• Class of share
• Dividend payment amount
• Authorising officer’s signature

Tax on Dividends

Every taxpayer must pay taxes on the total dividends in a tax year that exceed the tax-free dividend allowance, and the applicable tax rates depend on their total income from other sources. You can see more on tax-efficient payment methods for directors, including salary and dividends for 2023/24, here.

Dividend Waivers

Dealing with dividend waivers can become quite complex. The process explained here focuses on the necessary steps rather than legal precedents. When a shareholder chooses to waive their entitlement to a dividend, this must occur before the dividend payment date and involves a formal deed.

The deed of waiver requires the shareholder’s signature, and a witness, and should be submitted to the company. In practice, waivers should typically have genuine commercial motivations and not be employed solely to avoid tax.

It’s important for the company to possess enough retained profits to ensure the same dividend rate can be paid to all shareholders, including those who opt for a waiver. Please be aware of potential tax consequences if one shareholder receives more than otherwise possible, due to another shareholder’s waiver.

An alternative approach, instead of a dividend waiver, could involve the company issuing different classes of shares. You can read more on Shareholder Agreements here.

Dividends or Other Payments?

The regulations concerning dividends are not limited to dividends alone; they encompass any transfer of value (or distribution) to shareholders or related parties (with the status influencing the terms). This includes gifts and other transactions where value is transferred at less than its market rate (for instance, loans provided at rates below market standards can be considered distributions).

Directors who also hold shares often pay themselves through dividends in their capacity as shareholders, or through salary payments in their roles as directors or employees (see more on our Payroll Management Service here). They may also borrow money through director’s loan accounts or engage in a combination of these methods.

It’s important to note that the law governing dividends and other forms of distribution is concerned with the true substance of the transaction, not just how it’s labelled in the accompanying documents. Therefore, directors should have a clear understanding of the implications of the available options before proceeding.

Directors are advised to maintain appropriate documentation for their decisions, such as minutes from directors’ meetings or shareholder resolutions, to reflect the nature of transactions accurately. While it’s common to prepare minutes after a meeting, they should accurately capture the decisions made during that meeting and are best prepared at the meeting or soon afterward.

Does Your Company Have “Available” Profits?

The first step in determining whether a company has the profits to pay dividends typically involves reviewing its most recent annual accounts (see more on our Year End Accounts Service here).

These annual accounts usually feature a balance sheet section that displays figures like “retained earnings” or “profit and loss reserves.” However, for micro-companies, the balance sheet may simply present a single figure for “capital and reserves.” The key task is identifying which portion of these reserves qualifies as available for dividend distribution.

In the eyes of the law, these qualifying profits must meet the criteria of being “realised profits.” Profits resulting from the regular trading activities of the company generally, but not automatically, fall under the category of realised profits.

Unfortunately, the accounts may not clearly differentiate between profit reserves that are realised and those that are unrealised. Some companies have transactions that lead to entries in reserves that remain unrealised, such as property revaluations or specific intra-group transactions. Therefore, caution is necessary to ensure that dividends are solely sourced from realised profits.

For interim dividends, you don’t need full financial statements, but directors should have enough information to reasonably judge if there are enough “distributable profits” when the payment is made.

Has the Financial Position Deteriorated?

Directors must evaluate if the company’s financial position has deteriorated or improved since the accounts date used to assess available profits for dividends.

If any losses incurred after those accounts have reduced the previously realised profits, then dividends cannot be paid out of them to that extent. The longer the time between the date of the accounts and the planned dividend payout, the higher the potential risk.

Has the Financial Position Improved?

On the other hand, directors may believe that the company’s financial standing has improved since the date of the accounts used to evaluate available profits, potentially permitting a larger dividend distribution.

In such instances, new accounts, often referred to as “management accounts,” should be prepared to establish the updated available profits. These interim accounts should adhere to the same principles detailed earlier for calculating available profits.

For instance, if directors wish to use management accounts for this purpose, they must factor in the taxation on profits up to the relevant date and consider any other adjustments that might be necessary in statutory accounts but were not incorporated into the management accounts, such as accounting for impairments. See more on our Management Accounts Service here.

Should Your Company Pay Dividends?

Even if your company qualifies for dividend distribution based on the legal criteria explained earlier, directors should weigh up the practical repercussions of issuing dividends, particularly, how they might affect the company’s cash flow. You should ask yourself the following:

• Will the company face loan repayments that require available cash?
• If the company lacks sufficient cash reserves, can it secure reasonable terms for borrowing the necessary cash, and more importantly, is it wise to do so solely for dividend payments?

Directors should evaluate whether the company will remain financially sound after paying out the proposed dividend or any other distribution.

This assessment involves considering the immediate cash flow implications of a dividend and the company’s ongoing capacity to meet its financial obligations on time. Directors of a company facing financial challenges should seek appropriate professional guidance on cash flow forecasts – contact us today.

What if a Dividend Payment is Illegal?

Paying dividends beyond what’s available in profit or using capital when losses occur is considered “ultra vires” (or effectively “illegal”). The actions taken regarding improperly paid dividends depend on the recipient’s situation:

• If the recipient knows or reasonably believes that a distribution is unlawful, they’re obligated to repay it to the company.
• If the recipient is unaware that an illegal dividend was declared (for instance, in the case of a shareholder in a publicly traded company), there’s no such liability. However, in private companies controlled by directors who are shareholders, these members are assumed to be aware of the dividend’s legality.

One significant consequence of paying an illegal dividend may arise if the company goes into liquidation. If it’s discovered that illegal dividends were paid to directors within the three years leading up to insolvency, those directors might be required to reimburse the company. See more on our Business Recovery and Insolvency service here.

Need Help with Dividend Payments?

If you need guidance on paying dividends and whether it’s right for your company, our professional team are here to help. We can also assist with Year End Accounts, Bookkeeping Services, Payroll Management, and much more. Get in touch with us today, either through our online booking form, by calling 01743 562430, or by emailing hello@mercianaccountants.co.uk.