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HMRC internal manual

Company Taxation Manual

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Distributions: general: dividends, distributions and company law

Companies Act 2006

Introduction

References are to Companies Act 2006 unless otherwise indicated.

Some knowledge of UK company law is useful in understanding how tax law applies to dividends and distributions although in fact the tax law in this area, which is mainly reflected at CTA09/PART9A and CTA10/PART23, is not confined to internal UK situations.

CTA09/PART9A, added by FA09/SCH14/PARA1, deals with the charge on distributions received by companies. It is mainly focused on the treatment of dividends and other distributions received from non-UK resident companies, but it sweeps up the inter-company distributions exemption formerly at ICTA88/S208 (for a brief period, after Tax Law Rewrite took effect but before FA09 this exemption was at CTA09/S1285). CTA09/PART9A is dealt with at INTM65100 onwards.

ITTOIA05/PART4/CHAPTER3 (UK source) and CHAPTER4 (foreign source) deal with most aspects of the charge on distributions received by non-companies.

CTA10/PART23 looks at distributions from the distributing company’s aspect, containing the definition of distribution formerly at ICTA88/S209 onwards. It applies also for the purposes of CTA09/PART9A. The definitions may need to be applied by analogy when the distributing company is registered in a foreign jurisdiction and so governed by foreign company law.

Dividends

UK company law is more concerned, among other things, with when a distribution may be made, than when a dividend may be declared. Dividends arise as a consequence of a process of internal company governance, and company law simply gives a model for the corporate constitutional relationship (see the provisions, commonly known as ‘Table A’ in The Companies (Model Articles) Regulations 2008 SI2008/3229). These provisions (actually as Table B) first appeared in the Joint Stock Companies Act of 1856, only 12 years after incorporation by registration was introduced to meet the growing needs of commerce (there is more about incorporation at CTM00510).

Declaration of dividends

The Companies Acts thus do not provide who shall declare a dividend and, in particular, do not require a dividend to be declared by the shareholders in general meeting. It is possible to lay down in the company’s constitutional documents (formerly Articles and Memorandum of Association, referred to here as Articles) that the directors shall declare dividends. If the Articles are silent as to the payment of dividends, they are payable only when declared by an ordinary resolution passed by the shareholders in general meeting. If the Articles specifically provide that dividends are not to be declared in this way the directors will be entitled to declare a dividend without the sanction of a general meeting under their general powers.

This, however, is not the usual practice. It is usual for the Articles to provide that the shareholders in general meeting shall declare dividends, but sometimes the directors are given power to declare dividends to the exclusion of general meetings.

In practice, a distinction is drawn between a final dividend and an interim dividend, (meaning a dividend paid between annual general meetings). The Articles usually provide that:

  • final dividends may be declared by the company in general meeting but no dividend shall exceed the amount recommended by the directors (paragraph 70(2) of Schedule 3 to the 2008 Regulations, which is the model for public companies), and
  • the directors may ‘decide’ to pay interim dividends (paragraph 70(1)).

Before declaring an interim dividend, the directors must satisfy themselves that the financial position of the company warrants the payment of such a dividend out of profits available for distribution (see below under ‘Profits available for distribution’ and ‘Ultra vires and illegal dividends’). The general meeting cannot interfere with the directors’ exercise of their power to pay interim dividends (see Potel v CIR (1971) 46TC958). Where the Articles provide for the payment of interim dividends by directors, a resolution by the board to pay an interim dividend can be varied or rescinded at a later meeting of the board (see Potel and below ‘When is when a dividend is due and payable’). In addition, the dividend will be reflected in the accounts, and the shareholders must approve the accounts.

What is a dividend?

As there is no definition of dividend in UK tax or company law the question has to be answered by reference to the facts.

Some foreign jurisdictions may provide for a definition, and that definition may be relevant if a particular payment is made by a company in that jurisdiction. HMRC v First Nationwide [2012] EWCA Civ 278 concerned dividends paid by a Cayman Islands registered company. The Court of Appeal rejected the idea of dividends as necessarily payments out of income (based on the historical system of retaining tax from payments out of income, which had applied to dividends) and decided, in the context of a payment directly out of share premium (permissible under Cayman Islands law) that it is the form of the payment and not its origin which determines whether a payment is a dividend.

When is a dividend paid?

CTA10/S1000 (1) A refers to any dividend paid by the company. CTA10/S1168 (1) says ‘for the purposes of the Corporation Tax Acts dividends shall be treated as paid on the date when they become due and payable ….’. What is meant by due and payable is discussed below but for present purposes it is sufficient to know that a dividend may become due and payable on an earlier date than the one on which it is actually paid.

CTA10/S1000 (1) A and CTA10/S1168 (1) are interpreted as working together to deem a dividend as paid on the date it becomes due and payable. On this view the object of the predecessor of CTA10/S1168 (1) was to ensure that advance corporation tax under the system abolished from 1999 was linked with the due and payable date even if actual payment of the dividend was not made until later. It is not interpreted as deeming as paid dividends that would not otherwise be paid but rather as fixing the date of payment by reference to the due and payable date once it is paid. It follows that a waived dividend is not regarded as paid.

A dividend is not paid, and there is no distribution, unless and until the shareholder receives money or the distribution is otherwise unreservedly placed at the shareholder’s disposal, for instance by being credited to a loan account on which the shareholder has power to draw. The company was not required to include the dividend on its ACT return until the dividend had actually been paid, but interest on ACT was due under TMA70/S87 on the basis that the dividend was paid at the earlier due and payable date, which also determined the rate.

Other distributions, such as premiums on redemption of redeemable shares, are ‘made’ rather than ‘paid’ and the date of making the distribution needs to be determined on the facts.

When is a dividend due and payable?

This largely depends upon what powers the company relies on in paying its dividends. Companies’ Articles often provide that:

  • final dividends may be declared by the company in general meeting, and
  • interim dividends may be paid by directors from time to time.

The significance of this in present context is that a final dividend which has been properly declared and which does not specify a date for payment creates an immediately enforceable debt. If a final dividend is declared under the terms of a resolution that states that it is payable on a future date (a fairly common occurrence for quoted companies) then the debt is enforceable, and the dividend is due and payable, only on that later date. An interim dividend, on the other hand, may be varied or rescinded at any time before payment and may therefore only be regarded as due and payable when it is actually paid. Potel v CIR (1971) 46TC658 contains a clear exposition of this point at page 669.

What is meant by payment of a dividend?

A cheque is a written order addressed by a person (the drawer) to a banker to pay money, generally to some third party (the payee) and constitutes a promise to pay on common law principles (Marreco v Richardson [1908] 2KB 584). The issuing of a cheque or dividend warrant (in effect a cheque drawn by the company on its bank in favour of the shareholder concerned) renders a dividend paid at that time. If the company’s Articles so authorise, the sending of a dividend warrant by post will constitute payment and the company’s liability will be discharged (see Thairwall v Great Western Railway [1910] 2KB 509).

Where a final dividend is declared and the resolution fixes a later date for payment then the declaration creates a debt owing to the shareholder but the shareholder may take no steps to enforce payment until the due date of payment (or payments if by fixed instalments, see Potel). The due and payable date in such circumstances is the date fixed for payment and not the date of declaration.

In many small private companies the directors and shareholders are identical and dividends are often credited to the directors’ or shareholders’ account with the company. In the case of a final dividend the dividend is due and payable on the date of the resolution unless some future date for payment is specified.

In the case of an interim dividend (which, see above, does not create an enforceable debt and which can be varied or rescinded prior to payment), payment is only made when the money is placed unreservedly at the disposal of the directors and shareholders as part of their current accounts with the company. Payment is not made until such a right to draw on the dividend exists, expected to be when the appropriate entries are made in the company’s books.

If such entries are not made until the annual audit, not uncommon in a small company, and this takes place after the end of the accounting period in which the directors resolved that an interim dividend be paid, then the due and payable date is in the later rather than the earlier accounting period.

Profits available for distribution

At common law there is a basic principle that dividends or other distributions must not be paid out of capital even if the Articles of a company authorise such a payment: Re Exchange Banking Ltd, Flitcroft’s case (1882) 21 Ch D 519. Companies Act 1980 with provisions now consolidated at Part 23 of Companies Act 2006 largely replaced the common law. The overriding principle now is that a dividend or distribution to shareholders may only be made out of profits available for the purpose (section 830). A statutory code of profits in the legal sense appears in regulations made under the Companies Act - an example is The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations, SI2008/410 made under section 396. In general, the rules do not distinguish between capital and revenue profits but rather concentrate on the difference between realised and unrealised profits according to accountancy principles. All calculations for profits available for distribution must be taken from the relevant accounts. Not everything recognised in accounts is realised, notably where accounts are prepared under IFRS (International Financial Reporting Standards; an example is a gain on revaluation of an investment property). See below under ‘Determination of profits’.

The relevant accounts

Section 836 requires that companies determine the question of whether a distribution can be made, and its amount, by reference to the ‘relevant items’ in the ‘relevant accounts’. The relevant items are the profits, losses, assets, liabilities, provisions, share capital and reserves.

Primarily, the relevant accounts will be the company’s latest ‘annual accounts’ laid before the company in general meeting. In two cases, however, the last annual accounts will not be the relevant accounts. First, if the distribution would otherwise contravene the relevant criteria if reference were made only to the company’s last annual accounts, interim accounts may be resorted to (section 836(2)(a)). Secondly, if the distribution is proposed to be declared during the company’s first accounting reference period, or before the date on which its accounts in respect of that period are laid before the company in general meeting, the relevant accounts are described as ‘initial accounts’ (section 836(2)(b)). There are therefore three types of relevant accounts:

  • the last annual accounts, that is the standard accounts prepared annually under the Act (section 837),
  • interim accounts (section 838),
  • initial accounts, that is accounts prepared to allow for a distribution to be made by a recently formed company during the company’s first accounting reference period or before accounts are laid in respect of that period (section 839).

Where the last annual accounts are the only relevant accounts, the following three statutory requirements (section 837) must be complied with:

  • the accounts must have been properly prepared according to the provisions of the Companies Acts, and so as to give a ‘true and fair view’ (section 393), or prepared to such an extent that the matters outstanding are not material to the determination of the legality of a distribution,
  • there must have been an auditors’ report under Chapter 3 of Part 16 (subject to the usual exemptions from the audit requirement for certain companies),
  • if the auditors’ report is not unqualified, the auditors must state in writing whether the qualification is relevant for the purposes of testing the legality of the proposed distribution, and a copy of this statement must have been laid before the shareholders in general meeting.

Where interim accounts are used to decide the legality of a distribution the following three statutory requirements (section 838) must be complied with by public companies:

  • the accounts must have been properly prepared as to comply with the formal requirements of the Companies Acts both as to content and form, and so as to give a true and fair view; the directors must also sign the balance sheet,
  • a copy of the accounts must have been delivered to the Registrar of Companies,
  • an English translation, certified as correct, if necessary, must have been delivered to the Registrar of Companies.

Where initial accounts are used to declare the legality of a distribution the following five statutory requirements (section 839) must be complied with by public companies:

  • the accounts must have been properly prepared and signed in the same way as is required for interim accounts,
  • the auditor must have reported that the accounts were properly prepared,
  • if the auditors’ report is qualified, the auditors must state in writing whether the qualification is relevant to determining the legality of the distribution,
  • a copy of the accounts, the auditors’ report and any statement must have been delivered to the Registrar of Companies,
  • a certified translation of the accounts, the report and any statement must also be sent to the Registrar of Companies if necessary.

For private companies there are no similar statutory requirements relating to either interim or initial accounts. The accounts are therefore those necessary to enable a reasonable judgement to be made as to the amount of the distributable profits under the primary rule of section 830. It follows that the format of those accounts may differ from the annual audited accounts submitted as part of the company’s return.

Failure to comply with these requirements will mean that the distribution is unlawful (section 836(4)). Conversely, if for example directors correctly prepare interim accounts as above, a dividend paid on the basis of those accounts will be lawful, even if the annual accounts prepared later show an insufficient figure of distributable profits. The consequences of an unlawful distribution are considered below under ‘Ultra vires and illegal dividends’. The shareholders cannot agree to waive the requirements of the Act (see Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] 1Ch447).

Where a company has made a distribution by reference to particular accounts and wishes to make a further distribution by reference to the same accounts, it must take account of the earlier distribution and of certain other payments made, if any, as listed in section 840, in determining the validity of the further distribution.

Determination of profits

The Act lays down what may be termed the ‘balance sheet surplus’ method of determining profits available for distribution. Under this, a company can distribute the net profit on both capital and revenue at the particular time, as shown by the relevant accounts.

Section 830 lays down the basic rule, but it does not apply to investment companies and is qualified in respect of public companies by section 831. It states that a company’s profits available for distribution are its accumulated, realised profits (on both revenue and capital) not previously distributed or capitalised, less its accumulated realised losses (on both revenue and capital) not written off in a proper reduction or reorganisation of capital.

The inclusion of ‘accumulated’ is important, making it clear that the current year’s position cannot be taken in isolation. Realised profits include both trading profits and profits on the realisation of capital assets, but not unrealised profit arising as a result of a revaluation of assets. An unrealised profit cannot be used to pay up a debenture or amounts unpaid on its issued shares. However, an unrealised profit arising on the revaluation of a fixed asset may be used to calculate a sum which is then treated as a realised profit provided a sum for depreciation of the asset over a period is written off or retained. The amount that can then be treated as a realised profit is the amount by which the sum written off or retained exceeds the sum that would have been written off or retained for depreciation of the asset over that period if the profit had not been made (section 841(5)). Under section 841(2) realised losses for the purpose of section 830 include most provisions, for example for depreciation.

Public companies

It is not sufficient that a public company has available distributable profits under section 830. Section 831 imposes an additional capital maintenance requirement, to ensure that the net worth of the company is at least equal to the amount of its capital. A public company may only distribute profit if at the time the amount of its net assets, that is the total excess of assets over liabilities, is not less than the aggregate of its called-up share capital and its undistributable reserves, and only if and to the extent that the distribution does not reduce the amount of the net assets to less than that aggregate. Undistributable reserves are defined at section 831(4) as:

  • the share premium account,
  • the capital redemption reserve,
  • the amount by which the company’s accumulated unrealised and uncapitalised profits exceed its accumulated unrealised losses not written off, and
  • any other reserves which the company is prohibited from distributing by statute or its Articles.

Distributions in kind

Distributions in kind, or ‘in specie’ may arise in consequence of a sale, transfer or other disposition by a company of a non cash asset and are frequently encountered in group situations. They also commonly arise in transfers at undervalue to shareholders. The company may declare a dividend, often at the book value amount, which will be a dividend within CTA10/S 1000 (1) A - see CTM15200. If market value exceeds that amount, CTA10/S1000 (1) B and G need to be considered - see CTM15250. And there may be a distribution without declaring a dividend to which CTA10/S1000 (1) B and G (and not A) may apply.

Company law treatment is quite complex. Where the transferor company has any distributable profits - £1 is enough - then under section 845 it can transfer assets in return for consideration equal to book value, even if market value is greater (if there has been a revaluation of assets, further rules apply). But if the consideration falls short of book value the shortfall must be covered by distributable profits. If there are no distributable profits the transfer is an unlawful return of capital - Aveling Barford Ltd v Perrion Ltd [1989] BCLC 626. Section 845 was introduced subsequent to the decision, and was intended to clarify the result of it.

In a later case Progress Property Company Ltd v Moorgarth Group Ltd [2010] UKSC 55 the Supreme Court decided that the validity of a distribution should be determined by its purpose and substance rather than its form, and thus disposal at undervalue which was not permitted specifically by section 845 will not in all cases lead to the conclusion that the distribution was an unlawful return of capital. It will depend on the facts.

Ultra vires and illegal dividends

The question whether a dividend is unlawful or not is not a tax issue. It is rather the application of company law to the particular facts, and the tax consequences flow from those facts. This is a matter in the first case to be determined by the company, and particularly the company secretary who has a legal duty to ensure that the company acts lawfully, and so it will normally be the company or its advisers who first raise the point. Officers should not in general seek out cases in which it might be argued that dividends that have been paid are unlawful. An exception to this will be where the dividend is paid as part of some avoidance scheme.

There is a significant difference in the treatment of improperly paid dividends dependent upon the position of the recipient. Section 847 provides that 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] 25 Ch D 752 and Moxham v Grant [1990] 1 QB 88. 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 a reward for holding shares by way of dividend. When dealing with private companies controlled by directors who are shareholders, such a member ought to know the status of the dividend and it is expected that section 847 will apply in the majority of such cases.

Where a dividend is paid and it is unlawful in whole or in part and the recipient knew or had reasonable grounds to believe that it was unlawful then that shareholder holds the dividend (or part) as constructive trustee in accordance with the principles stated by Dillon L J in Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] 1 Ch at page 457. Such a dividend (or part) is void for the purposes of both the IT charge on distributions under ITTOIA05/S383 and the long abolished ACT charge under ICTA88/S14. The company has not made a distribution as a matter of company law, and so the dividend does not form part of the recipient’s income for tax purposes. The company has not parted with title to the sum that it purported to distribute, which as a consequence remains part of its assets under a constructive trust (see also Ridge Securities Ltd v CIR (1964) 44TC373). Where the company concerned is a close company, it is regarded as having made a loan to the shareholder by virtue of CTA10/S455(1), thereby triggering a charge under CTA10/S455(2). Relief would however be available under CTA10/S458 where the dividend is repaid to the company. That repayment might be by cash or cheque, or by a suitable entry in the loan account.

A shareholder who had no knowledge of the illegality of the dividend and no reasonable grounds on which so to believe is not a constructive trustee and does not have to repay the sum, which will constitute a distribution under CTA10/S1000 (1) B. If such a shareholder then repaid the company (although not liable to do so) this is simply a voluntary assignment or transfer of the shareholder’s own income so that it does not affect the tax position. However, in practice it is desirable to consider all such cases on their particular facts and merits.

Dividend waivers

The waiver of a dividend is only possible before payment. An act that purports to be a waiver after payment is no more than an assignment or transfer of income, which may constitute a settlement vulnerable to the settlements legislation of ITTOIA05/PART5/CHAPTER5. A waiver properly made before payment involves more formality than a simple request not to pay dividends or to pay them elsewhere. As discussed above, see ‘When is a dividend paid?’, IT liability depends on whether a dividend is, or is not, actually paid. A waiver can be effective for all future dividends, or for any future period of time, or for specific dividends.

ACT liability also turned on the payment of a dividend. If there was no payment, whether or not because of an alleged waiver, then there was no ACT liability. If, however, payment had been made because the waiver was ineffective the ACT liability remained irrespective of what subsequently happened to the funds.

Uncashed dividends

Prior to 6 April 1999, under the ACT system on declaring a final dividend the company assumed two liabilities; a liability to the shareholder for the dividend and a liability to the Revenue for the ACT. There was nothing in the legislation which absolved the company from meeting its liability simply because the shareholder had received the dividend warrant but had decided for some reason not to pay it into their own bank account, or to endorse it to another. The shareholder had effectively assigned and not waived income. The time limit to recover dividends is generally six years (see section 5 Limitation Act 1980 and Re Compania de Electricidad de la Provincia de Buenos Aires Ltd [1978] 3 AER 688). The time limit runs from the declaration of the dividend or the declared date of its payment, whichever is later, unless the shares are in bearer form. In that case, if the contract by which the company undertakes to pay dividends requires the share warrant to be presented before payments can be made, no cause of action arises until such presentation.

In Scotland the time limit to recover dividends is five years (section 6 Prescription and Limitation (Scotland) Act 1973). The time limit allowed by general law is subject to variation, and a company can adopt Articles giving shareholders a shorter time to claim. The London Stock Exchange listing rules require at least 12 years. Companies at this time might write back uncashed dividends in their books. This does not mean that any ACT accounted for at the time of payment can be repaid.