Taking dividends after a loss-making year

Yes or no to dividends?

Most company owners probably already know that in most circumstances dividends are the most tax-efficient form of income they can take from their company. They probably also know that companies can only pay dividends if they have profits at least equal to the dividend they want to pay. For companies that have had their business decimated by the pandemic, this might pose a problem.

Example part 1. Acom Ltd has traded for several years. Its financial year ends on 31 March. The director shareholders take most of their monthly income as dividends which won’t exceed its profits. In 2020 trading was hit by the pandemic and the director shareholders stopped taking dividends. The good news is that in the last couple of months business has returned to profitability. However, the director shareholders can’t resume paying dividends until they are sure the company has sufficient profits.

Profits, losses and distributions, e.g. dividends, from previous years must be taken account of to establish whether a company has sufficient “retained profits” to pay further dividends.

Example part 2. As at 1 April 2020 Acom had retained profits of £30,000. By July that year the director shareholders had been paid dividends of £24,000 and anticipated that current losses would wipe out the remaining £6,000 of retained profits. They stopped any further dividends.

When can dividends resume?

Profits from which dividends can be paid are those shown by the latest “relevant accounts”. This means the company’s “last annual accounts” or interim accounts. Where does this leave Acom’s directors given that the last relevant accounts, to 31 March 2020, showed retained profit of £30,000. In July 2021 can Acom pay dividends based on this figure despite knowing that £24,000 of that profit has been paid as dividends and that in the next financial year the company made a loss?

Yes or no to dividends - again?

Acom could legitimately pay dividends in July 2021 based on its 2020 accounts. However, if when the 2021 accounts are finalised they show a loss which together with the £24,000 dividends paid in that year wipes out all retained profits, dividends could not be paid until Acom could show it had sufficient retained profits. But that’s not the full picture.

What about “overpaid” dividends?

If Acom’s losses for the year to 31 March 2021 exceed £6,000, let’s say they are £20,000, it would not in hindsight have even had enough profit to pay the £24,000 of dividends it did: retained profits of £30,000 less losses of £20,000 leaves just £10,000 profits for dividends so it overpaid £14,000. The bottom line is that although the director shareholders were acting in good faith at the time, £14,000 cannot be dividends and must be recategorised.

HMRC might try to argue that the £14,000 is earnings liable to PAYE tax and NI but as the dividend was paid in good faith the excess should be treated as a loan to the shareholders. As far as the current year is concerned, to prevent a potential dispute with HMRC, the directors could take further loans and repay them from dividends when they are sure there’s enough profit.