Paying dividends (don't want to take another thread off-topic) - The Book-keepers Forum (UK)

Peasie · Expert

Paying dividends (don't want to take another thread off-topic)

Shamus · Forum Moderator & Expert

REPEAT OF THE RESPONSE ON OTHER THREAD.

Hi Peasie,

Think this one deserved it's own tread as may get interesting when Bill finds!

It's common practice to take dividends during the period but if the company is loss making as would be indicated here then it shouldn't be paying dividends.

However, such is a bit late when an interim dividend has already been paid.

A dividend is a dividend regardless as to whether it's a one man company or a multinational paying out to thousands or shareholders. As such once a dividend has been paid then it cannot just be taken back again.

At the time that the dividend was paid in the example the entity was in profit with no reason to suspect that such would not be the case at the period end.

Just to note here. I'm only talking about dividends on ordinary shares not preference shares which are quite differnet and in certain circumstances payment of dividends for preference shares could legitimately result in an entity going overdrawn.

There's an interesting current discussion around this point over on accounting web. Espechially in relation as to whether once a dividend has been issued can HMRC enforce it's override and reversal.

Have a glance at this thread :

http://www.accountingweb.co.uk/anyanswers/can-you-reverse-dividend/492472

AccountFiles · Veteran Member

Dividend is meant to be a financial rewards paid to shareholders of a company after a financial period's proft(usually at least one financial year) has been worked out after tax.

Big or most companies only pay out a part of the profit as dividend and plough back in the rest into the company to increase working capital.

So I really dont see why dividend should be calculated under a 6 months period calender, tax charged thereafter, and company accounts drafted afterwards.

It could be worked out on paper of course, but as a matter of accounting principle and best practice, I doubt.

Peasie · Expert

I have no idea what has been happening to my posts - unrelated I had to reboot my computer as trying to print a pdf on the HMRC website froze the computer. I have no idea how my post ended up with a white background or how my other post ended up on that information forum.

I'm at an early stage of my studies as regard shares and dividends. Even when I've completed level III with ICB I would still be at a very early stage. The reason I mention this as any notes I've read regarding preference shares is they could only be paid up to the level that profits allowed.

So as long as you have the figures to show the company was in profit at the time the interim dividend was paid you should be ok?

Just when I think I'll be at a stage when I can start advertising for work (I'll soon be finished level III ICB) I realise just how little I know. I can do all the things in the assignments and exams - but they are NOTHING like the real world.

Shamus · Forum Moderator & Expert

Hi,

taking the increase in profit by amounts not taken out of the company out of the equation, you will find that most large companies try to keep major investors (normally the pension companies) sweet by paying an interim dividend.

going back to smaller companies which is all that most of us here will be concerned with, the original thread related to the practice of paying dividends with the same regularity as salary payments which my arguement was that such was not really a legitimate approach and gave the common alternatives.

See here or follow Peasie's link for the original posts :

http://www.book-keepers.org.uk/t42746090/payroll-question/?r=174559

The payment of regular dividends for small companies is common practice. If you think about it micro businesses quite often lack the resources for directors to maintain their lifestyle throughout the period whilst waiting to determin the amount of the end of year dividend available to them.

If they pay themselves as salary then the money is not available in the company to be paid as a dividend.

That's why I suggested that the dividends based on DLA was a better approach than using the regular dividends based on current profit levels as a model. Such would also mean that if there was insifficient profit to cover the DLA then it may have to be regarded either as salary or a withdrawal of owners capital from the business.

Personally when I take a dividend it is only once per year but I appreciate that not everyone is in the position to do that.

Wella · Expert

Did some one mention my name?

This link to HMRC is the simplest on aspects of dividends

http://www.hmrc.gov.uk/manuals/ctmanual/ctm20095.htm

Found it a bit of a struggle but paragraphs 20 to 22 seem to say that a balance sheet surplus can be used to determine profits for distribution.

Paragraph 22 goes on to say that it may not be necesary to take the current year performance in isolation and accumulated profit can be considered (with exceptions for investment companies and public companies)

Shaun enjoy the read.

Bill

PS I only scanned over this article so may need a reread later

Shamus · Forum Moderator & Expert

Hi Peasie,

it's one of those subjects that accountants have strong, but often diametrically opposed views over.

There are all sorts of shares and they have different rights attached to them. The most common are ordinary and preference shares. If you think of ordinary shares as you owning a part of the company and preference shares as though you have loaned money to the comany you won't be far wrong.

You will normally find that with preference shares the rights attached to them dictate a level of interest, or guaranteed dividend payable annually.

If a company does not have the profit to pay preference shareholders then the dividend / interest can (by agreement in the conditions of the shares) be carried forwards to the next period. The point though is that the money regardless of payment is still owed to the shareholders.

Preference shares will almost always take preference over ordinary shares unless the rights attached to the shares specifically state otherwise.

On a seperate note I for one would say that you're more than ready to start advertising. This is one of those businesses where one is perpetually learning and if you waited until you knew absolutely everything then (a) you would never get to start your business and (b) the standards setters (ASB, IASB, etc) would just change everything!

Shamus · Forum Moderator & Expert

Hi Bill,

Like yourself I've only scan read so far but from what I've read I think that I was too lenient in my initial appraisal.

It does read as though my suggestion for smoothng the eventual dividend against profit by using the DLA is the only legitimate approach as the link makes the profit expectation quite clear.

No profit, no dividend, no exception for interims.

One line that to me makes the situation abundantly clear is :

"payment is only made when the money is placed unreservedly at the disposal of the directors/shareholders"

So a profit that becomes a loss in the same period would surely mean that the money was not placed unreservedly at the directors disposal and to treat it as such would be going against the companies act.

I'll have a more detailed read when I've got my boy to bed tonight but cheers for that that link, it's a good one.

Shaun.

gbm · Guru

It does happen that a business makes a profit in the first half of the year, pays out a dividend and then trade takes a turn for the worse so that it reports a loss for the year. It is the directors responsibility to show that they declared a dividend legally. In the event that a company is wound up, the IP has the power to ask for the dividend back if it was taken illegally. I had this a couple of years ago with a client who was taking dividends from his company even though it was insolvent. I might add that this happened before my appointment!

Wella · Expert

Hi Shaun

My quick scan led to me to believe that if there were available reserve that weren't locked in, that the accumulated undistributed profits from previous years can be released to dividend.

Obviously, where the accumulation results in a loss then no.

Bill

AccountFiles · Veteran Member

It all still comes to the fact that no year end accounts computation, no profit declaration, no dividend payments!

That is the generally acceptable accounting principle, I believe. So paying dividend before year end account is made seem to me unrealistic.

Stardoe · Guru

Shamus wrote:

If they pay themselves as salary then the money is not available in the company to be paid as a dividend.

Does that mean that if directors pay themselves a regular monthly salary then they are not allowed to take a dividend as well?

(I'm still at the early stage of shares and dividends as well like Peasie!)

Pauline

ADAS · Guru

Stardoe wrote:
Does that mean that if directors pay themselves a regular monthly salary then they are not allowed to take a dividend as well?
(I'm still at the early stage of shares and dividends as well like Peasie!)
Pauline

Hi Pauline

They can do both.

I think part of the confusion for people is salary and dividends are rewards for two completely different things.

A salary is a reward paid to employees of a company

A dividend is a reward paid to owners of a company i.e. shareholders.

As far as I know Bill is spot on and dividends can be declared from retained earnings, which is a distributable reserves

hth

-- Edited by ADAS on Monday 9th of May 2011 09:36:28 PM

Stardoe · Guru

Thanks Tony. 'Scuse my ignorance again, but if a director takes a dividend do they pay tax on that?

Pauline

HendyPhilhendy · Guru

Nick aka GBM has nailed it really. If there was no indication that a major loss was going to be incurred then you would declare the dividend. Remember the same principal could apply if you awarded a dividend on the final day of the year. If you had raised a sales invoice for say £100k on 31st December (your year end) the company could declare a dividend as they would expect the cash. If on 31st January the debt became very bad you would potentially have to look at the consequences as Nick mentioned.

ADAS · Guru

It depends on the their total earnings. Someone else will post the exact figures, but if a Director is a basic rate tax payer then no further tax is due of dividends.

For a higher rate tax payer, dividends are taxed at 32.5% (salary 40%)

For a top level tax payer dividends are taxed at 42.5% (salary 50%)

Also dividends don't attract NI.

That's basically why it's a popular way for Directors who are also shareholders in a Company to maximise there earnings and mitigate tax.

(from memory)

-- Edited by ADAS on Monday 9th of May 2011 09:45:28 PM

HendyPhilhendy · Guru

I usually take a similar approach to Shamus, reviewing the dividend situation immediately prior to the year end in a pre year end client meeting. Occasionally some clients will do quarterly dividends but I tend to avoid monthly.

HendyPhilhendy · Guru

Accountfiles - perhaps the rules are slightly different under US accounting principles?

Stardoe · Guru

Many thanks Tony!

Pauline

AccountFiles · Veteran Member

Hendy,

When taking out dividend monthly or quarterly, how do you work out the year's tax and possible actual profit?

Unless you work out profit at the end of the quarter, put aside the tax acrued to the quarter and payout dividend on what is left. keep repeating same all year round.

Ofcourse this way, the possibility of shareholders oweing the company because of excess dividend paid out to them in view of a projected year end profit will not arise.

Since it will be a case of, no profit, no payment. As opposed to paying indiscriminately now and looking for remedies later when eventually the income statement shows red.

Or how else do you treat it quarterly?

My kind regards.

HendyPhilhendy · Guru

AccountFiles wrote:
Hendy,
When taking out dividend monthly or quarterly, how do you work out the year's tax and possible actual profit?
Unless you work out profit at the end of the quarter, put aside the tax acrued to the quarter and payout dividend on what is left. keep repeating same all year round.
Ofcourse this way, the possibility of shareholders oweing the company because of excess dividend paid out to them in view of a projected year end profit will not arise.
Since it will be a case of, no profit, no payment. As opposed to paying indiscriminately now and looking for remedies later when eventually the income statement shows red.
Or how else do you treat it quarterly?
My kind regards.

The point is that you prepare reasonable management accounts and have no belief for there not to be a profit. Without reasonable information you cannot make an informed decision. If you have the information and later things go wrong you have still made the best decision lessening the potential of an administrator to claw it back.

HendyPhilhendy · Guru

The links here are pretty clear on it

http://www.hmrc.gov.uk/manuals/ctmanual/ctm20095.htm

Shamus · Forum Moderator & Expert

Hi Accountfiles,

just reading through the follow up posts and came accross this line in your response

"Of course this way, the possibility of shareholders oweing the company because of excess dividend paid out to them in view of a projected year end profit will not arise".

That is not a possibility that will arise anyway for normal shareholders. I would say that such would only be applicable to directors or those in close proximity to the directors such as their wife or husband (and even that may be in question considering the review of what denotes a related party).

Note that some of the following is quoted directly from ctm20095

The dividend can be cancelled anytime up until payment but once paid section 277 of the companies act comes into play.

A recipient member who knows or has reasonable grounds to believe that a distribution or part of it is unlawful is liable to repay it or that part of it to the company.

No such liability exists in respect of a member who is an innocent recipient. The immunity of an innocent recipient shareholder is illustrated in Re Denham & Co [1883] 25ChD752 and Moxham v Grant [1990] 1QB88. This principle relates mainly to the liability of a shareholder in a quoted company, who cannot be expected to have detailed knowledge of the day to day running of the company, but simply receives his reward for holding shares by way of dividend.

This is quite different to a situation where directors who know that the company does not have sufficient profit to pay the dividend do in fact pay themselves a dividend out of non existent profits in which case the dividend is repayable to the company.

P.S. amended because when mentioning related parties I forgot to mention the amendments applicable to IAS24 which means that close family members will not necessarily be considered related parties. For accounts prepared under UKGAAP close family members would of course still be considered related parties.

-- Edited by Shamus on Tuesday 10th of May 2011 11:50:02 AM

gbm · Guru

HendyPhilhendy wrote:
Accountfiles - perhaps the rules are slightly different under US accounting principles?

I don't think accountfiles is American, despite the US address on the website. There are references to HMRC and Co House on the 'business' page (although the 10 month deadline for Co House is now defunct). Also, if you click on the 'accounting services' link on their home page, it goes through to a business based in Essex.

AccountFiles · Veteran Member

Hello gbm,

If you notice, we do not have our website on this forum yet, that is because it is still under construction and not yet ready to the public (which is why you may had noticed some pages were totally blank).

So the US address you saw is the sample address of the website design company. And yes, we are a UK bookkeeping company intending to serve London, Essex and its environs.

And I still believe it is good practice to pay dividend yearly or at least quartely only after profit has been worked out. In which case you avoid the situation raised by the author of this thread (please refer to his/her first article).

My kind regards.

gbm · Guru

Thank you Accountfiles.

I like your rather tactful appraisal of Peasie's gender; I must admit I was surprised when I found out!

Just out of interest, how would you deal with a new company where the director needs cash on a monthly basis for living? Large salary or loan?

Shamus · Forum Moderator & Expert

Hi,

I think (with some more minor differences of opinion) that there's general agreement here in the treatment of dividends but we all seem to be approaching our answers from slightly different angles.

just so that it doesn't get forgotten, this thread is actually a continuation of a conversation between Amanda and myself re dividends started in this thread :

http://www.book-keepers.org.uk/t42746090/payroll-question/?r=174559

My standpoint originated from my statement that dividends are paid only against profits and should not be paid monthly and gave the common alternatives for smaller entities who do not find it feasible to work to an annual dividend.

My advice to a director of a company would never be to take monthly dividends, however, a dividend paid into the DLA annually or half yearly could be paid on a monthly basis or money taken from the DLA could be reimbursed by way of the declaration of a dividend.

So, as you can see, I think that we are all actually in agreement here... Was an excellent discussion though which hopefully will serve to inform many of the people who read these threads that the decision to issue a dividend is not quite as straightforwards as what the director wants but rather it brings into play complaince with section 277 of CA85.

on a completely different dubject, whats your first name AccountFiles as if we're going to be chatting on here a lot it seems a little impolite to keep using your userid. Some of us (thinking of myself here) have our own real nicknames as userids so for me it doesn't matter if someone refers to me as Shaun or Shamus (or even Mutley for that matter).

kind regards,

Shaun.

gbm · Guru

Just for the record Shaun, I don't agree with monthly dividends. I know they can be done if the paperwork is correct, but they look too much like remuneration for comfort.

Shamus · Forum Moderator & Expert

Hi Accountfiles.

Peasie's a bloke. real name Stuart.

Hi Nick,

The directors should talk to their bank (or alternate financial institution) about an overdraft to get them through the first six months (more flexible than a bank loan where the situation is expected to change for the better relatively quickly).

They will need to guarantee the overdraft personally based on other assets such as their house or first born child (I work in banking, first born children are acceptable collateral! (lol)).

The directors can draw a salary against the overdraft but not take a dividend as the company is not yet in profit.

Shamus · Forum Moderator & Expert

Hi Nick,

as I said, we're all in agreement. That's my approach as well.

The original post related to a director being paid a minimal salary and a much larger monthly dividend. My argument was that to receieve a monthly sum the dividend would be paid quarterly or half tyearly into the DLA and the director could take the money from the company as they wished, weekly, monthly, quartely, annually. It doesn't matter providing that the dividend that provides the funds for the DLA is only declared against profits.

So, as an example, Dividend of £6000 declared mid year and the director takes £1000 from the DLA each month for six months. There was only one dividend even though the money was not taken out of the company in one chunk.

Preferably this would be annuallised so one dividend declared against profits then the director could take it all at once or over a series of withdrawals from the DLA.

ADAS · Guru

There's an interesting blog post at the link below, which is worth reading. It's written by an insolvency practitioner.

http://www.cheapaccounting.co.uk/blog/?p=1650

-- Edited by ADAS on Tuesday 10th of May 2011 05:01:24 PM

Shamus · Forum Moderator & Expert

Excellent link Tony that relates straight back to Peasie's original question about what happens when a profit turns to a loss. Or as the Chris McKay on the blog puts it, when the music stops.

gbm · Guru

Shamus wrote:

Hi Nick,

The directors should talk to their bank (or alternate financial institution) about an overdraft to get them through the first six months (more flexible than a bank loan where the situation is expected to change for the better relatively quickly).

They will need to guarantee the overdraft personally based on other assets such as their house or first born child (I work in banking, first born children are acceptable collateral! (lol)).

The directors can draw a salary against the overdraft but not take a dividend as the company is not yet in profit.

Huh? Why bother when they can lend from their company, then declare a dividend to clear the loan?

This is what happens in practice. In t' real world. Honestly.

We are not talking about PLC's, we are talking about small business.

Please, please, please don't quote the Companies Act to me! smile

Shamus · Forum Moderator & Expert

Hi Nick,

are we not agreeing with each other????

When the company is in profit then if that's the way that they want to go they can declare a dividend to clear the DLA which is what I've been saying all along.

However, your question was how would you deal with a new company where the director needs cash on a monthly basis for living?

The issue there is that with a new company there may be no money in the company so it needs an overdraft (or short term loan) until the entity is making a profit at which time dividends can be paid against profits.

The directors can, overdraft permitting borrow from the company even where such takes the company overdrawn. If the company makes a profit then as discussed this could then be cleared by way of a dividend but if the company does not make a profit then no dividend can be declared to clear the DLA in which case how is the shortfall accounted for?

As you know the DLA needs to be brought back to zero and if it can't be cleared either with a dividend or capital injection back into the company by the director then to my mind it's salary.

P.S. I think the quote from the companies act was aimed more at the response to accountfiles... like the way that I purposefully avoided mention of section 455 (formerly 419) in the above response. lol

gbm · Guru

I think we were agreeing, but if you want an analogy, think of someone who is s/e. they earn money, which goes into their bank account, which they draw to live on.

If that same person operates through a ltd co, they would probably take £589 p/m salary, but that isn't enough to live on! Therefore they need further funds. Hence, the need to fund their life, which is typically to take a loan from the company and delcare a dividend to balance up.

NB there is always the proviso/risk that the company may not make sufficient profit to declare a dividend, and the need to live well within their means cannot be stressed enough.

Sorry this is brief, 5 things I want to do before sitting down with a nice glass of wine to shout at the 'candidates' on the Apprentice!

gbm · Guru

BTW, S419...ah, happy days!

HendyPhilhendy · Guru

I think you guys and me are all agreeing in a roundabout fashion! I know it is a generalisation but for a small owner managed business cash in bank = profit for owner to take (allowing for a tax provision) I too wouldn't encourage declaring a monthly dividend just in case.

My only comment would be to discourage a company overdraft for personal expenditure. This would only encourage the overdrawn directors loan implications. If they need additional personal funding then a personal overdraft should be obtained.

AccountFiles · Veteran Member

Pretty interesting discussion we have here, I admit!

Peasie,

I hope you totally understood my remark. I didnt want to offend you by addressing you wrongly since it wasn't clear if you a lady or a gentleman, and I hope I didnt (please dont mind gbm) :).

gbm,

I hope you were not trying to set me up? Lol! Anyways..., dividend, large salary or loan? Based on the 3 options you have given, for the books to be proper, I would say dividend should come after profit and definately not monthly. Large salaries attract large taxes, so wouldn't help tax avoidance if that is what you are set to achieve.

Loan yes, but depending on how it is treated. If a company does her periodic accounts properly; declares profit and post agreed sums regularly into a reserve account, a director can take out a loan from there and pay back regular neglegible interest! At the end of the period (say financial year end) after profit is worked out the company can declare dividend, regularise the reserve, loan and dividend accounts. That way, the book is happy, the directors , the company, HMRC are happier!

Remember profit does not necessarily mean cash. A company can make profit but still dont have cash cos cash has been loaned out. As good practice, it is always advisable to maintain a good cash flow system and advoid indiscriminate withdrawals in case of insolvency.

Shamus,

Lol! My name is Stephen.

My warmest regards.

Peasie · Expert

AccountFiles wrote:
Pretty interesting discussion we have here, I admit!
Peasie,
I hope you totally understood my remark. I didnt want to offend you by addressing you wrongly since it wasn't clear if you a lady or a gentleman, and I hope I didnt (please dont mind gbm) :).

As I spend a lot of my internet time on Scottish football forums it will take quite a bit to offend me.

Given the amount of posts I'm glad I took this topic to another thread.

gbm · Guru

Hi Stephen,

I wasn't trying to set you up. I've been on my own for 7 years nows and it's always interesting to get perspective on what other practices are doing.

When we take limited company clients from other (larger) practices, often ICAEW, it's amazing how often the niceties of dividend paperwork are missing, or how dividends are declared post year end but dated pre year end to avoid the beneficial interest due on an overdrawn DLA.

And yes I appreciate that profit does not necessarily mean cash. Conversely cash does not always mean profit. I have seen dividends declared on the basis that 'there's a healthy bank balance, so we must have made profit' - yes but you've ignored creditors, tax, etc..!