Companies can pay dividends of their post-tax profits to their shareholders, or instead reinvest those profits in the business.
Paying a dividend is a type of company distribution. Dividends can be interim dividends or final dividends. Interim dividends are paid during a company’s financial year and typically made through a decision of its board of directors. It may be possible for the board to rescind its resolution to pay an interim dividend prior to payment. Final dividends, however, are made after finalisation of the company’s annual accounts and are typically declared by the shareholders following a recommendation from the board of directors.
It is important to check the company’s articles of association for the procedure and authority to pay dividends, whether there are any restrictions and whether any class of shares needs to receive preferential treatment.
For a distribution to be lawfully paid the company must have sufficient profits which are available for distribution and it must be justified with reference to the company’s accounts. A distribution made out of capital or declared in excess of the company’s distributable profits is unlawful. The company’s solvency status should also be considered as a distribution (even if otherwise lawful) may be a transaction at an undervalue if the company is insolvent.
Directors owe a number of duties to a company and a dereliction of duty may result in director disqualification. A director who authorises payment of an unlawful dividend may breach their directors’ duties and can in some circumstances be found liable to personally repay the company. It is therefore important that directors take due care and consideration when making decisions to pay a distribution.
A dividend in specie is where a dividend is first declared and then satisfied by the transfer of a non-cash asset (such as a property). Whereas a distribution in specie occurs when a company makes a distribution of a non-cash asset without first declaring an amount in monetary terms.
The terms dividend in specie and distribution in specie are sometimes used interchangeably but they may have different Stamp Duty Land Tax treatment for which tax advice should be sought.
When non-cash assets are transferred by a company to its shareholders (or a sister company) it is important that they are valued. Where a transfer takes place at below market value then this is a distribution in specie.
If a company has negative distributable reserves then the shareholder (or sister company) must pay market value for the non-cash asset as the company cannot lawfully make a distribution.
However, if the company does have sufficient distributable reserves then the value of the distribution in specie received by the shareholder is determined by the Companies Act 2006. In short, the company must have sufficient distributable reserves for the difference between the book value of the asset recorded in the company’s accounts and the amount of the consideration paid by the shareholder (if anything).
A shareholder who knows or has reasonable grounds to believe that a distribution is unlawful is liable to repay it (or the part which is unlawful).
It is important that directors making or shareholders receiving a distribution from their company ensure that it is lawful and has been properly recorded. Advice should be considered given the potentially significant consequences of unlawful distributions.
For further information or advice, please contact BHW’s corporate team on 0116 289 7000 or email info@bhwsolicitors.com.