Dividends: A Guide to a Successful  Payment

This blog establishes the process and requirements for the payment of a legal dividend.
It is crucial to recognise that the payment of dividends is subject to a rigorous legal framework. Regardless of the scale of the organisation, this framework is applicable. The dividend will be considered illicit and may result in severe repercussions if the appropriate procedure is not adhered to.

What is a dividend?

A dividend is a method by which a company distributes funds to its shareholders.

A beneficial (and potentially tax-efficient) method of providing additional income to an owner/manager is dividends. They can also be employed to transfer funds between company divisions or to reward investors.

The most prevalent varieties of dividends are as follows:

• Final dividends are distributed annually after the preparation of the annual accounts. They are typically “declared” (authorised) by the shareholders and recommended by the directors.
• Interim dividends are typically declared by the directors and may be paid at any time during the company’s financial year.

Declaring a legal dividend

A number of legal conditions must be satisfied before the payment of a dividend.

1. The organisation must generate a sufficient amount of distributable profits.

Dividends must be distributed from “profits available for the purpose” by the Companies Act 2006. These are the company’s cumulative realised profits, which are less than its accumulated realised losses.

The proposed dividend must not be declared or paid if the available profits are insufficient to fund it.

2. Accounts must be referenced to justify dividends.

The directors must possess a set of accounts that demonstrate an adequate level of distributable profits.

The accounts must be either:

• The most recent annual accounts of the company; If the annual accounts indicate that there are insufficient distributable profits, the dividend must be justified by reference to more recent “interim accounts”; or
• “Initial accounts” must be prepared if the dividend is declared during the company’s inaugural accounting period.

3. The directors are required to evaluate the company’s current and future financial status.

The accounts are just one part of the picture, as they will have been prepared before the directors are determined to distribute a dividend.

Consequently, directors are obligated to meticulously evaluate the organisation’s:

• current financial position at the time of their decision (if any changes have occurred since the date of the accounts); and potential future financial position should the dividend be paid.
• Directors must be confident that the company will be able to satisfy its ongoing obligations and liabilities, even if there are insufficient distributable profits to pay the dividend.

The company must also possess the necessary funds to distribute the dividend. The issues discussed in this paragraph are pertinent to the cash position.

4. Verify the articles of association of the organisation.

Provisions regarding dividends are typically included in the articles of incorporation.

For instance, dividends may be payable exclusively on shares that have been completely paid. Alternatively, dividends may be restricted to a specific class of shares. Typically, shareholders are entitled to receive dividends in proportion to the number of shares they possess; however, it is important to verify the articles. Additionally, the articles may specify a specific method for authorising dividends.

5. Comply with the responsibilities of directors

Directors are obliged to consider their obligations when the decision is made to declare a dividend. This encompasses obligations to:

For instance, if a director is also a shareholder, they will be required to declare an interest in the proposed payment. Additionally, they must exercise reasonable skill and care and act within their power to promote the company’s success for the benefit of its members.
Safeguarding the organisation’s assets is one of these obligations.

6. Record the declaration decision.

The process of proclaiming a dividend should be documented in the board minutes that directors prepare. This should encompass a discussion of the financial information that was utilised and the directors’ responsibilities that were assessed.

Consequences of declaring an unlawful dividend

The dividend will be considered unlawful if the appropriate procedure is not adhered to, and there are potential severe repercussions, such as:

• If a shareholder is aware or has reasonable grounds to believe that the dividend violated legal regulations, they will be required to repay the company the entire amount or the illicit portion. It will be challenging for the shareholder to avoid this liability if they are also a director
• A director who authorised the payment of the dividend may be held personally liable for repaying the company, even if they are not a shareholder if they have violated their director’s duties.

If you require any advice on this matter, then please get in touch with your usual Complete Clarity contact.