Dividend or salary? A cautionary tale...

Dividend or salary? A cautionary tale...

The Court of Appeal has recently considered whether dividends received by a director/shareholder were lawful. In common with many businessmen, Mr Hale followed the advice of his accountants to structure his remuneration in a tax efficient way. He awarded himself a small salary each month to cover national insurance contributions, and any excess was paid as a dividend. 

Dividends may only be lawfully paid if there are sufficient distributable reserves to support their payment. In the case of interim dividends paid part way through a financial year, assuming that the company’s last annual accounts do not show sufficient distributable profits to support a dividend, directors should satisfy themselves by drawing up interim accounts that the company has sufficient distributable profits at the time of payment. 

In this case, monthly interim dividends were paid without reference to accounts. However, at the end of the relevant financial year, the accountants would check whether there had, in fact, been sufficient distributable reserves at the time to support payment of the monthly dividend. If not, the accountants would “reverse” the dividends and re-characterise them as salary.

Between January 2014 and October 2015 Mr Hale received £23,511 in dividend payments, each of which was recorded as an “interim” dividend in a dividend tax voucher prepared by the accountants for HMRC. When the company went into voluntary liquidation, this practice of paying dividends which were subsequently re-characterised as salary came under scrutiny, and the liquidators argued that the dividends had been paid unlawfully under section 830 CA 2006 on the grounds of insufficient distributable reserves. They requested repayment, which was refused.

The judge in the High Court accepted that because the company had no profits available for distribution at the relevant times, the payment of £23,511 would be unlawful and therefore repayable. However, in cross-examination of Mr Hale, the judge held that the decision to make payments as dividends was properly characterised as provisional, a “decision in principle”, subject to the accountants’ confirmation at the end of the financial year as to whether those payments could lawfully be made. As there had been no valid decision to pay the dividends, the obligation to repay did not arise.  The judge therefore dismissed the claim for £23,511 to be repaid. 

The Court of Appeal unanimously overturned the High Court decision. The trial judge was criticised for asking leading questions, and wrongly focusing on Mr Hale’s intention when authorising monthly payments to himself as dividends, rather than on the payments themselves. The real question was whether the payments when made were lawful distributions of the company’s assets. Reference to dividends having been declared “definitively” or “provisionally” was incorrect and inappropriate (since there is no concept of “provisional” dividends under English law). The dividends had been unlawfully made and were liable to be repaid. 

Directors should note the lessons from this case, and ensure that they apply their minds to the level of distributable profits in the company every time they make a decision to pay a dividend. Accountants cannot carry out retrospective adjusting exercises to re-characterise payments as salary if it appears that, with hindsight, the necessary profits did not exist.   

Case: Global Corporate Ltd v Hale [2018] EWCA Civ 2618.

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View profile for Kathryn SaundersKathryn Saunders, View profile for Claire MillerClaire Miller

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