What happens if I take too many dividends from my company?

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    It’s a widespread misunderstanding that company earnings are readily available to its owners. However, it’s essential to declare dividends lawfully; otherwise, the directors and company may face penalties or, at the very least, tax and accounting challenges.

    A limited company must have available profits to pay dividends; otherwise, they are considered illegal dividends. The payments may be reclassified as a director’s loan, but this incurs corporate and personal tax. If the company is near insolvency, the director also risks personal liability for company debts.

    In this article, we’ll examine the best way for UK company directors to extract profits from their limited company and how to distribute dividends legally. We’ll also provide guidance on what to do if your company pays excessive dividends.

    For advice on corporate and individual tax, please get in touch with the tax experts at Jameco Group.

    How many dividend payments can you make in a financial year?

    The number of dividends that can be paid to shareholders in a tax year is unlimited, provided the company is in profit. Dividends are distributed from retained earnings after all expenses and obligations are covered.

    Paying dividends without adequate profits can lead to legal and tax complications, including penalties from HMRC.

    It’s wise to carefully manage the amount of profit retained within the business to maintain healthy cash flow and ensure the company remains financially stable.

    This not only covers ongoing operational costs but also supports future investments or unexpected expenses. Always ensure there’s enough money in the company’s bank account after dividends have been paid to meet these needs.

    What are illegal dividends?

    Declaring dividends without sufficient distributable profits to cover the payment is considered an ‘illegal dividend’. ‘Distributable profits’ are the company’s profits left after all obligations such as Corporation Tax, loan repayments, salaries, and other expenses have been settled.

    Declaring an illegal dividend is not a criminal offence if due to a genuine oversight, but it can have serious consequences, especially if the company is nearing insolvency. Directors have a legal obligation to be aware of their company’s financial status at all times. Failing to acknowledge the company’s financial distress or insolvent position could result in financial penalties. Taking too much dividend also hints at significant managerial or governance failures.

    Company directors can also be held personally liable for repaying illegal dividends, underscoring the importance of rigorous financial management. This is where the services of an experienced accountancy firm like Jameco Group can be very valuable.

    Can overpaid dividend payments be corrected with a director’s loan account?

    If dividends are paid out but later found to be unlawful, they cannot be cancelled, but they can be corrected using a director’s loan account. The payments are reclassified as a loan from the company to the director, which the director must repay.

    For non-director shareholders, the situation differs slightly. They are generally not required to repay the dividends unless they were aware, or should have reasonably known, that the dividend was improperly declared.

    Any funds withdrawn from the company that are not classified as salary, expenses, benefits, or legal dividends are considered a director’s loan. These transactions must be recorded in the director’s loan account.

    If you withdraw more than you’ve contributed, the account is considered overdrawn; if you contribute more than you withdraw, it is in credit. Managing this account properly is crucial to avoid tax issues and ensure legal compliance.

    Tax implications of taking too many dividends

    Taking excessive dividends has potential consequences for both company directors and the limited company itself. Let’s take a look at the tax implications:

    Corporation tax

    While a company does not pay tax on dividend payments, it must pay an additional charge known as a Section 455 tax if a director’s loan is not repaid within nine months and one day after the company’s fiscal year-end.

    This tax is set at 33.75% of the outstanding loan amount. Although it can be reclaimed once the loan is fully repaid, it increases the company’s financial burden in the interim.

    Moreover, while the corporation tax on this charge can be reclaimed upon repayment, the interest paid on the outstanding loan amount cannot be recovered.

    Income tax

    When a director’s loan exceeds £10,000, it is considered a benefit in kind. The director must pay tax on the benefit if the company does not charge the director interest at the official rate published by HMRC or if the interest charged is below this rate.

    The director must declare this on their self-assessment tax return, and it can significantly increase their personal tax liability.

    If you fail to document withdrawals from the business as dividends, HMRC might classify them as director’s salary payments, which are taxed at a higher rate than dividends. Along with a higher tax bill, you could also face penalties, compounding the cost of the oversight further.

    Always ensure your dividend distributions are supported by available profits and properly recorded to avoid these costly mistakes.

    Tax efficiency

    As a limited company director, deciding on the most tax-efficient way to extract profit is crucial. The optimal approach often involves drawing a salary up to the personal allowance limit (which is tax-free) and then taking additional income as dividends.

    Dividend tax is significantly lower than income tax, which, combined with the tax-free dividend allowance, makes this strategy typically the most tax-efficient method of profit extraction.

    However, if you withdraw excess dividends – and retained profits aren’t available to support them, this benefit can quickly become a liability. You could face significant tax consequences and come under scrutiny by HMRC.

    For more information on taking salary or dividends, see our blog Should I take a salary or dividends?

    Looking for further accounting advice? Get in touch with Jameco Group

    Deciding how much to pay yourself in dividends isn’t just about how much profit your limited company makes.

    Choosing when and how to extract company profits in a tax-efficient manner involves balancing your personal financial needs with your company’s financial performance and growth objectives. At Jameco Group, we’re here to help you get that balance right.

    Want to make sure you’re using dividends smartly? Get in touch with us at Jameco Group.

    James Wheeler, founder and managing directors of Jameco Group
    James Wheeler

    James has over 10 years of experience in accountancy and taxation. He has a real passion for business and truly believes SMEs are the heart of the UK economy. In 2017, he founded Jameco Group to provide first-class accountancy, taxation, and business advisory services to individuals and SMEs across the UK.

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