A dividend is a reward of value, which can be paid out either as cash or in the form of additional product, distributed to the shareholders in return for their investment in a company’s equity. Usually a dividend takes the form of a payment from the company’s net profits.
How to Distribute Dividends
The majority of a company’s profits is retained within the company to fund their ongoing business. The remainder can be allocated to the shareholders as a dividend. Essentially the distribution of dividends, is a transaction that transfers value to a shareholder (or related party), the terms of which are arrived at because the other party was a shareholder (or related party). The law on distributions applies to dividends, but also to gifts and other transactions at undervalue. An example would be a loan distributed at below-market rate. Directors who are also shareholders often pay themselves through dividends (as shareholders) or remuneration (as directors or employees,) or borrow money through director’s loan accounts, or blend these forms of how to distribute dividends.
Legal Dividend Payments
Directors on the board are personally liable for any amount paid in dividends unlawfully. So it is important to understand what is permissible. Only profits available for the purpose, may be paid out in dividends. This will be in accordance with company law, rules and procedures which are written into the company’s constitution. Shareholders who receive unlawful dividends are required to repay the amount in full if they were aware of the facts that made them unlawful, even if they did not understand that this made the dividend(s) unlawful. Where shareholders are also directors, facts known to them from acting in either capacity will be relevant in proving the legality. The law on dividends, applies to the substance of the transaction, not merely because of how it is described in the related documentation, inclusive of other forms of distribution. This is why it is important to understand the nature of the consequences of available alternatives, before proceeding. Prestige Business Management can guide you through how to distribute dividends and make the most of the opportunities open to you, whilst maintaining compliance. Directors need to document every decision in meeting minutes and record shareholder resolutions – appropriate to reflect the substance of the transaction. A good point to make here is that it is usual to practice to produce minutes of each of your meetings – often published and distributed after the date of the meeting, but these need to accurately present the shareholder decisions made at that meeting. Documents that are effectively backdated run the risk of committing fraud.
Profits Available to Pay Dividends
The company’s last annual accounts circulated to shareholders will typically indicate what profits a company has available to pay in dividends. Usually the balance sheet in those accounts will state “retained earnings” or “profit and loss reserves”. The balance sheet for a micro-company will simply show a figure for “capital and reserves”. It is crucial to determine what element of those reserves qualify as available to pay dividends. By law, these are profits that qualify as “realised profits”. Profits from normal trading activity are typically (but not automatically) realised profits. Dividends may only be paid from realised profits. An unrealised profit is a potential profit that exists on paper, resulting from an investment. It is an increase in the value of an asset that has yet to be sold for cash, such as a stock position that has increased in value but still remains open. Some companies have transactions that result in entries in reserves that are unrealised. A profit becomes realised once the position is sold for a profit. It is possible that if an unrealised profit is not sold in time that the potential profit could be erased if the position loses its profit value before it is sold. Unrealised profits could be revaluations of properties or certain intra-group transactions. Financial statements drawn up by the entity. However, certain entities are required to get their books of accounts audited so that external entities can rely on them. Companies subject to audit requirements under the Companies Act 2006, are subject to additional considerations where the auditor’s report is qualified. Auditing is the function of independently evaluating the books of accounts of an entity to report as to whether they represent a true and fair view of the entity’s financial position. An auditor’s report is qualified when there is either a limitation of scope in the auditor’s work, or when there is a disagreement with management regarding application, acceptability or adequacy of accounting policies. For auditors an issue must be material or financially worth consideration to qualify a report.
Deterioration of Financial Position
The longer the gap between the date of the accounts and the proposed dividend payment, risk is increased that the realised profits in those accounts have been reduced by subsequent losses. In this case the dividend cannot be paid out to the proposed value. Directors need to consider whether the position has deteriorated since the date of the accounts used for assessing profits available to pay dividends.
Improvement of Financial Position
It is possible that the financial position has improved since the date of the accounts are being used to assess profits available to pay in dividends. This allows the dividends to be paid to potentially increase in value. In this case, interim accounts should be prepared to determine the profits are available. Interim accounts should follow the same principles for calculating available profits as already outlined. For example, if the directors want to use management accounts for this purpose, they will need to take into account tax on profits to the relevant date and consider other adjustments that might be required in statutory accounts but that have not been included in management accounts, such as impairments. Impairment exists when an asset’s fair value is less than its carrying value on the balance sheet. An impairment loss records an expense in the current period which appears on the income statement and simultaneously reduces the value of the impaired asset on the balance sheet.
Dividends are not Guaranteed
Dividends cannot be guaranteed and how to distribute dividends depends on the profitability of the company according to its most recent accounts. Dividends should only be paid out in the event that the company has sufficient profits available for distribution. Directors should consider the practical consequences that might arise from paying out dividends, including the impact on the company’s cash flow. If the company does not have cash reserves, there is the potential to borrow cash in order to pay dividends. However the benefit would need to outweigh the financial obligation of repaying this sum with interest. This means considering the immediate cash flow implications of a dividend and the continuing ability of the company to pay its debts on time. Any company experiencing financial difficulties should seek professional accounting advice. Prestige Business Management can provide guidance and expertise in managing dividend payments and cash flow for businesses of all sizes.
Intra-Group Transactions
Profits available for distribution will dictate how to distribute dividends. These are calculated at the individual company level and based on the accounts for that company. Where a company belongs to a group, dividends cannot be paid out by the group if an individual company has accumulated losses. Even if the group including its own subsidiaries is profitable. Intra-group transactions are common within groups of companies. For instance, one company may transfer a property to another at cost (below market value), transfer of tax losses for a consideration that is not arm’s length or leave the price as an intra-group loan. Undervalue transactions require careful consideration by the companies involved. Professional accounting services can provide the expertise required to evaluate such transactions.
The Process for How to Distribute Dividends
If conditions are satisfactorily met that dividends may be distributed after taking into consideration all of these factors then Directors may proceed.
In particular:
- the intended dividend is covered by the balance of realised profits within the last annual accounts circulated to shareholders or in more up to date interim accounts
- realised profits have not been subsequently lost
- dividend payments do not leave the company unable to pay debts on time
- if the company is subject to audit, the legal requirements apply where the auditor’s report is qualified
The process for how to distribute dividends will be contained within the company’s articles of association. Final dividends are usually paid annually after the annual accounts have been approved. This instruction should typically state this process for how to distribute dividends:
- directors recommend a dividend
- dividends to be declared by ordinary resolution (eg by vote at an AGM or written resolution)
- members cannot vote to pay more than the amount recommended by the directors
Articles also typically state the process for the directors to pay “interim” dividends at any time. The intended dividend should be subjected to the legal qualifiers outlined that are outlined here from the start of the process and throughout up to the point at which the dividend becomes a legally binding liability on the company. A final dividend is declared by the members even if it is stated to be due at a later date, as is usual, or at the point when an interim dividend is actually paid. The company should keep records of the payments, that the dividend was supported by relevant accounts and minutes of directors’ or shareholders’ meetings. Under tax legislation, the company must send the shareholder (or the bank or building society if the dividend is paid into a bank or building society account) a certificate stating the amount of the dividend and the date of the payment.
At Prestige Business Management we can help your Business
Prestige Business Management can provide guidance and expertise in how to distribute dividends and maintain cash flow for businesses of all sizes. Call us today on 0203 773 2927.
