This helpsheet has been issued by ICAEW’s Technical Advisory Service to help ICAEW members understand whether or not a dividend is considered legal and the implications of illegal dividends.

Members may also wish to refer to the following related guidance:

• TECH 02/17 BL Guidance on Realised and Distributable Profits under the Companies Act 2006

Under section 830 of the Companies Act 2006, a company is only entitled to make a distribution out of profits available for the purpose. Profits available for the purpose are the accumulated realised profits less accumulated losses. This is a complex area and reference should be made to TECH 02/17 BL Guidance on Realised and Distributable Profits under the Companies Act 2006 for guidance.

A dividend must be supported by relevant accounts to demonstrate that there are sufficient profits available for distribution in accordance with the Companies Act 2006 section 836. The relevant accounts will be the company’s last annual accounts or where there are insufficient profits available for distribution in those accounts, interim accounts.

Additionally common law requires that capital is maintained and therefore losses since the relevant accounts need to be considered. Directors also have a fiduciary duty which means that when proposing a dividend, directors will need to look at the ability of the company to meet its debts as they fall due in the future (public companies also need to consider additional requirements which are not explored within this helpsheet).

Qualified audit report

If there is a qualified audit report on the last accounts, an auditor’s statement must be circulated to members along with the accounts to say that the qualification is not material to the company’s ability to pay the dividends. FRC’s Bulletin 2008/9 Miscellaneous Reports by Auditors Required by the United Kingdom Companies Act 2006 includes an example of such a statement as Example 1.

Dividend process

Another aspect of dividends to consider is the process and paperwork to make a lawful dividend payment. For the directors to pay a dividend, they must hold a directors’ meeting to consider the relevant accounts and declare the dividend. They will need to keep minutes of the meeting, even if there is only one director.

In addition, the directors will need to prepare the dividend voucher at the time the dividend is declared/paid. A dividend voucher must show the company’s name, the name of the shareholder, the amount of the dividend and the associated dividend tax credit and finally the date paid. This paperwork should be current and not created at a later date. A dividend must usually be paid to all shareholders of a class. If one or more shareholders do not want to receive a dividend they must execute a legal waiver of their dividend entitlement.

Special case – donations by a company to its parent charity

• TECH 16/14 BL Guidance on donations by a company to its parent charity gives guidance on the application of company law on distributions in the specific case where the shareholder is a charity.

The Companies Act 2006 section 847 confirms that where shareholders have received a distribution (e.g. a dividend) from the company knowing at the time that there were insufficient reserves available for the purpose, then they are liable to repay the illegal portion.

When profitability deteriorates later in the year after directors have paid interim dividends, the year-end financial statements may show a cumulative loss on reserves. Provided the directors had previously substantiated the interim dividend, the liability to repay would not normally arise.

Disclosure requirements

If the dividend was not supported by relevant accounts and the reserves are now in deficit, directors should make full disclosure in the notes to the accounts. For example, a disclosure that the dividend was not supported by relevant accounts and either that it is liable to be repaid or that it was received by shareholders unknowingly. Where the shareholders are directors themselves, they would not be able to state that they received the dividends unknowingly.

The directors should also state that they undertake to make no further distributions until such time as there are reserves available for the purpose. Even if there are distributable profits, without proper paperwork to confirm the payment as a dividend, any payments to the shareholders would be treated as loans and therefore shown as a debtor in the balance sheet. Moreover, a demand to repay the dividend would be likely in the case of insolvency.

Impact on an audit report

If full disclosure is made in the notes to the accounts to explain the situation then it is possible, in fact probable, that the auditors will not need to qualify their audit report. The auditors would, however, need to assess recoverability of any debtor and, if appropriate, consider qualifying their report on the basis of doubts over the going concern of the company.

ICAEW members, affiliates, ICAEW students and staff in eligible firms with member firm access can discuss their specific situation with the Technical Advisory Service on +44 (0)1908 248 250 or via webchat.