A dividend is unlawful if the company does not have enough distributable profits to pay it at the time. In an owner-managed company this happens more often than people think, usually because dividends are taken monthly to a set amount without anyone checking the profits are there.
An unlawful dividend can be reclaimed from the shareholder, can leave directors personally liable, and can be treated by HMRC as a loan, with a tax charge on the company. The fix is mostly about checking the figures and keeping the right paperwork.
What counts as distributable profits
Under the Companies Act 2006, a company can only pay dividends out of profits available for the purpose. Broadly, that is its accumulated realised profits less its accumulated realised losses, taking into account all previous years, not just the current one.
In practice, the starting point is the profit and loss reserve on the last balance sheet. Corporation tax due on profits must be allowed for, and any dividends already paid reduce what is left.
The decision must be justified by reference to relevant accounts. That is normally the last annual accounts. If you want to pay a dividend based on profits made since then, or if the company has made losses since then, you need interim accounts that show enough reserves.
How it goes wrong
A company has a profit and loss reserve of £15,000 at its last year end. The director takes a dividend of £2,500 a month, as in previous years. Trading has slowed, and management accounts show a loss of £5,000 for the first part of the new year.
The distributable profits are now £15,000 less £5,000, which is £10,000. By the end of the year the director has taken £30,000. Around £20,000 of that was unlawful.
Other common causes are dividends declared before the year end accounts are finished, dividends that ignore the corporation tax bill, and amounts drawn through the bank and labelled dividends later without any decision being made at the time.
The consequences
- Repayment by the shareholder. A shareholder who knew, or had reasonable grounds to believe, that the dividend was unlawful must repay it to the company. In a company where the director and shareholder are the same person, that knowledge is very hard to deny.
- Director liability. Directors who authorise an unlawful dividend can be personally liable to repay it, which matters most if the company later becomes insolvent and a liquidator looks back at what was paid out.
- Tax as a loan. Where the dividend is repayable, HMRC may treat the amount as a loan to the shareholder. If it is still outstanding nine months and one day after the year end, the company pays section 455 tax. The rate is 35.75 percent for loans made on or after 6 April 2026. On the £20,000 above, that would be £7,150. The tax is refunded nine months after the end of the period in which the loan is repaid, so it ties up cash for a long time.
The paperwork
A valid dividend needs a clear paper trail made at the time, not reconstructed later.
- Board minutes recording the directors' decision, the amount per share and the date, with reference to the accounts relied on.
- For a final dividend, shareholder approval where the articles require it.
- A dividend voucher for each shareholder showing the date, amount and shareholding.
- Payment in proportion to shareholdings within each class of share, unless the articles allow otherwise.
If you think a dividend was unlawful
Do not ignore it. Options usually include treating the excess as a director's loan and repaying it, or, if the shortfall arose only because accounts were not prepared in time, preparing interim accounts that show the profits did exist. The right answer depends on the figures, so take advice before changing the records.
What to do
- Check reserves before each dividend, using up-to-date management accounts that include a corporation tax provision.
- Prepare interim accounts where the last annual accounts do not support the dividend.
- Minute every dividend and issue vouchers at the time it is paid.
- Review your director's loan account regularly so that drawings are not mislabelled.
If you would like us to check your reserves before your next dividend, book a free call.
