Recent case highlights the importance of correctly declaring dividends
A recent case, Re BM Electrical Solutions Ltd, has found a director-shareholder liable to repay sums which were held to be director loans despite having been recorded as dividends in the company’s accounting software package.
For tax saving reasons, the director-shareholder had agreed to a very low salary (net £11,702) on the basis that he could claim other monies as dividends.
After falling into financial difficulty, the company was wound up on 3 August 2015. Upon his appointment, the liquidator identified that transfers of approximately £220,000 had been made to the director-shareholder over a three and a half year period. The liquidator accepted that credit should be given to the director for his salary but claimed that the balance should be treated as loans from the company to the director, which should be repaid.
At trial, the director stated that a small proportion of the sums paid to him were his salary, whilst the rest of the payments were entered onto the accounting software package under a code for ‘dividends’. This was claimed to be a tax efficiency measure.
However, after the first year of trading, the director did not cause any further accounts to be prepared, meaning that the company only ever filed one set of accounts (for the period to 31 January 2012, filed on 11 August 2012).
Judge Lance Ashworth QC held that the sums paid to the director-shareholder were to be treated as director loans made with the expectation that there would be sufficient profits each year to pay them off. The reasons for this were two-fold.
For a dividend to become payable, it must be declared. As the director could not show that he had made such a declaration, he could not argue that the payments received should be treated as dividends.
Notwithstanding the above, a declaration (and subsequent payment) of dividends must be conducted in accordance with Part 23 of the Companies Act 2006. Under Part 23, a company may only pay dividends out of profits available for the purpose and those profits are to be determined by reference to profits, losses, assets and liabilities ‘as stated in the relevant accounts’ (s830 and s836). Those relevant accounts are the last annual accounts or interim accounts if the distribution would otherwise contravene Part 23. Given that no accounts had been drawn up since 2012, even if the payments were considered to be distributions, they would still be considered unlawful as the formalities in Part 23 CA 2006 had not been compiled with.
Accordingly, the director was required to repay the sums to the company (s847 CA 2006).
This case highlights the importance of correctly declaring shareholder dividends. Directors should ensure that dividends are formally and correctly declared in accordance with Part 23, otherwise there will be no liability on the company to pay it.
The judgement also provides a reminder of the risk to director-shareholders who agree to accept a nominal salary on the basis of being able to draw further funds as dividends.
The clarity given by this judgment will be welcomed by officeholders seeking to recover purported dividend payments made to director-shareholders in excess of their salary.