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A dividend is a distribution of accumulated profits that can be paid to a company’s shareholders.

Overview

This article explains what a dividend is and is not, which can result in illegal or unlawful dividends. Hopefully, this article will enable you to be assured that a dividend that you draw will not have to be repaid as may well be the case in respect of an illegal or unlawful dividend. However, please take note of the disclaimer at the end of this article.

So, what is a dividend? A dividend is a shareholder’s right or entitlement to a sum of money from a company. It is not merely the payment of that sum of money from the limited company.

Meaning of Dividend

Although it is common to refer to the payment of a dividend with the dividend itself, it is not the case that the payment of a dividend is the dividend.

The Companies Act 2006 enables subject to certain conditions that we will come onto, for shareholders to receive dividends. In a nutshell, a dividend can only be paid from profits. This is to protect the company’s creditors so that a company’s wealth or money is not extracted by the shareholders at their expense. The conditions for a dividend mean that the payment of a dividend should not result in creditors going unpaid.

Declaring A Dividend

If a Director wishes to pay a dividend to the limited company’s shareholders, he or she has to DECLARE the dividend otherwise it is not created.

In order to declare a dividend, the Board of Directors will need to pass a board resolution to formalise the declaration. The resolution should ensure that it refers to the accounts that are relied upon to justify the dividend. These are referred to as the RELEVANT ACCOUNTS accounts which are discussed later in this article.

An example of such a Board Resolution can be seen here:

Dividend Board Resolution

Dividend Voucher

To record the dividend a dividend voucher should be issued to each shareholder to show what they are in receipt of. This will be part of their tax records.

An example of a dividend voucher can be seen here:

dividend voucher

Why Are Dividends Declared?

Dividends are declared because the company’s shareholders that own the company will want to receive a return on their investment in the company. Such return can typically take two forms:

  1. Receipt of regular dividends.
  2. Sale of the shareholding.

Tax Efficient Dividend Income

The receipt of dividend income is often in the case of owner-managed SMEs, taken instead of the Directors drawing a salary. This is typically part of a tax efficiency strategy of extracting an income from a limited company. A key benefit in drawing an income by way of dividends is that there is no Employers National Insurance for the company to pay on the dividends paid by the company.

The potential saving in declaring dividends instead of drawing a salary, is that on funds extracted for each Director/Shareholder in excess of £8,844, there would be no Employers National Insurance at the rate of 13.8% to pay.

Consequences Of Failing To Declare The Dividend

If payment is made to a company’s shareholders intending it to be a dividend without having been properly declared then the transaction is not a dividend. The consequence of such a failure is that the transaction may well have to be reversed and repaid to the company as Mr Belcher found out in the matter of BM Electrical Solutions Ltd & Anor v Belcher [2020] EWHC 2749 (Ch) which has featured in our post Ouch! Director Dividends, Director Loans and Director Liability.

What Are The Conditions For A Dividend?

Dividends Can Only Be Made Out Of Profits

In order to consider what is a dividend? you need to break down all the special features of dividends. Dividends can ONLY be declared out of profits. You can see from the extract of Section 830 of the Companies Act 2006 the restriction imposed.

distributable profits

What Are The Profits Available For A Dividend?

The profits available for a dividend are the accumulated realised profits.

Profits are not simply cash in the limited company bank account.

Profits are also not the ‘net’ profit figure shown on the last Profit and Loss Account of the company.

Accumulated Profits Example Of Fraser Group Plc

So for example let us have a look at the accumulated profits of the Fraser Group Plc. This is Mike Ashley’s company that amongst other things is part of the Sports Direct Group.

The last balance sheet for the Fraser Group Plc was published at UK Companies House for the 52 weeks ended 26 April 2020 or at the Fraser Group Plc’s investor section of its website.  We can see at the bottom section of the balance sheet is a section referred to as Capital And Reserves. Within that section is a line that says Profit And Loss Account. We can see that the Accumulated Profits are a massive £170,900,000 as at 26 April 2020.

Fraser Group plc Balance Sheet

Accordingly to Wikipedia Mike Ashley owns 61.7% of Fraser Group Plc. So he could with the agreement of the Board of Directors look to declare a dividend of £170,900,000 of which he could expect to receive a dividend of £105,445,300.

If Mike Ashley wanted now to receive £105,445,300 not only would it be necessary for the Accumulated Profits to be £170,900,000 but it would also still be proper to consider Directors’ Duties. That would involve a review of the current financial position and if the Accumulated Profits had since 26 April 2020 dropped below £170 million then the position should conceivably take adequate account of that change. However, that is just ensuring that you work with up-to-date information and do not ignore the obvious.

Sequana Court Case

The Courts have become embroiled in consideration of the calculation of Accumulated Profits and whether or not you need to take account of what might result in losses in the future, such as those arising from contingent liabilities.

However, what we know from Mrs Justice Rose in the case of BTI 2014 LLC v Sequana S.A. & Ors [2016] EWHC 1686 (Ch) is that it appears that you do not if the accounts show a true and fair view. More about that later when we consider distributable reserves.

Justification Of A Dividend With Reference To Relevant Accounts

In order to declare a dividend, the calculation of the Accumulated Profits cannot be some back of a fag packet or rough and ready calculation. Before a dividend can be declared it is necessary to ensure that the calculation of Accumulated Profits is accurate. To ensure that the figures relied upon are accurate it is necessary to justify them with reference to ‘relevant accounts’.

What Are Relevant Accounts?

Relevant Accounts are those referred to in Section 836 of the Companies Act 2006.

relevant accounts

In essence ‘relevant accounts’ are accounts that adhere to the requirements of Section 396 of the Companies Act 2006 and which also thereby comply with the applicable Accounting Standards.

So what does that mean in practice? It means that the relevant accounts are accounts that show a True and Fair View. There is no statutory definition to the True and Fair View concept but it tends to mean that a set of accounts showing a true and fair view should be assembled using accounting policies that are appropriate, consistently applied and adequately disclosed. The True and Fair View concept has been set out in more detail by the Financial Reporting Council that is an accounting regulator.

Section 836 of the Companies Act 2006 permits a dividend to be declared provided the required account is taken (for the purposes of considering the accumulated profits available) of a company’s profits, losses, assets, liabilities, provisions, capital and reserves.

Sequana Court Case

What the Sequana Court Case said was that when calculating profits available for the purposes of Section 830 of the Companies Act 2006 (distributable reserves) it was not necessary to go beyond the categories set out in Section 836(1) of the Companies Act 2006. In other words, you do not need to take account of contingent liabilities that may have been referred to for example only, in the notes to the accounts.

The wording of section 836 focuses on the numbers used in the accounts as opposed to the other narrative parts. Thus, section 836(1) provides that the lawfulness of a distribution is determined ‘by reference to the following items as stated in the relevant accounts’. For our purposes, these items are those in section 836(1)(a), that is profits, losses, assets, liabilities, those in paragraph 88 of Schedule 4 to the Companies Act 1985 (namely provisions relating to depreciation or diminution in the value of assets) and those in paragraph 89 of Schedule 4 (namely references to any amount retained as reasonably necessary for the purposes of providing for any liability the nature of which requires provision for accounting purposes). This focus on amounts rather than narrative is apparent too from section 837(2) which qualifies the requirement that the accounts must be properly prepared by stipulating that this is ‘subject only to matters that are not material for determining (by reference to the items mentioned in section 836(1)) whether the distribution would contravene this Part’. This requirement that any defects in the accounts must relate to material items is further reinforced by section 837(4) which envisages that even a report qualified by an auditor can support a lawful distribution if the auditor states in writing that the matters in respect of which his report is qualified are not material for determining whether a distribution would contravene Part 23.

If the ‘relevant accounts’ show a true and fair view then the calculation can be a simple one.

Are Relevant Accounts Essential If You Are Solvent?

The answer is yes, relevant accounts are an essential component in the procedures that need to be deployed to declare and pay a dividend. They are not optional.

They exist to protect creditors from suffering what would conceivably otherwise be losses capable in theory of being avoided.

Queens Moat Houses Plc Court Case

This point was highlighted in the Queens Moat House Plc Court Case. The full reference is Bairstow & Ors v Queens Moat Houses Plc [2001] EWCA Civ 712 in which Lord Justice Robert Walker said:

… the requirement that any distribution should be made only in accordance with a company’s financial statements, drawn up in the proper format and laid before the company in general meeting, cannot be regarded as merely a procedural technicality.

What Happens If The Requirements For A Dividend Are Not Met?

If the requirements are not complied with ie. the dividend is an unlawful or illegal dividend then if a shareholder knows, he or she will have to repay the dividend in light of Section 847 of the Companies Act 1986.

consequence of unlawful dividend

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