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HMRC internal manual

Company Taxation Manual

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HM Revenue & Customs
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ACT: General: Ultra vires dividends

Within close companies, where there is an identity between shareholders and directors, dividends often replace fees as the source of the directors’ remuneration with the advantage of minimising liability for NIC.

Prior to 6 April 1999 this procedure was viable from the company’s point of view if it had enough ACT capacity.

However, this was not always straightforward.

Assume, for example that a company had inadequate distributable reserves on its last audited accounts. It purported to pay an interim dividend during an accounting period (accounting for ACT under ICTA88/SCH13). When drawing up its audited accounts after the end of the period, it found that there were insufficient distributable reserves to cover the dividend.

What action can be taken?

Frequently the dividend is found to have been paid unlawfully. If that is the case, the company’s advisors will be able to rectify the situation by reducing or extinguishing the amount of the dividends and drawing up approved accounts showing only such amount of dividends as can be supported by distributable profits. Corresponding adjustments will be made to directors’ loan accounts, if the dividends have been credited to such accounts in the company’s books, or in draft accounts. At that point the company was likely to seek recovery of the ACT paid corresponding to the dividend reduction.

The question whether or not a dividend is lawful under company law is primarily a matter for the company, and in particular its secretary. In general you should not challenge the alleged unlawfulness of dividends unless the amounts involved are substantial and you suspect a tax avoidance scheme or there are other special circumstances.

How to treat ultra vires dividends that are repaid

Where a dividend is ultra vires (in whole or part) and the shareholder knew or had reasonable grounds to believe that the dividend was unlawful (as normally would be the case where the shareholder is also a director) then the shareholder receiving the dividend, or that part of it, holds it as constructive trustee for the company. To that extent, the dividend is likewise void for the purposes of ICTA88/S209 since the company has not made a distribution as a matter of company law, and the dividend does not form part of the shareholder/recipient’s income for tax purposes. The shareholder is under an obligation to return the dividend, or that part of it, to the company.

If, in the circumstances just described:

  • the ultra vires dividend, or that part of it, has actually been paid in cash and the shareholder returns the cash to the company, or
  • the ultra vires dividend, or that part of it, has been credited to a loan account where it has remained undrawn, and the loan account is subsequently rewritten to exclude it when the approved accounts are prepared,

any ACT paid in respect of the ultra vires dividend, or that part of it, would have been repaid to the company.

In Garforth v Newsmith Stainless Ltd 52TC522 it was held that the placing of money unreservedly at the disposal of the directors as part of their current accounts with the company was equivalent to payment. But it cannot be said that any loan account entry in the company’s books or draft accounts in respect of an ultra vires dividend creates such an unreserved right where:

  • entries reflecting the ultra vires dividend are removed from the approved accounts,

and

  • the shareholder/director is obliged to repay the amounts held by him or her as a constructive trustee.

How to treat ultra vires dividends retained

You may find that a close company has paid an ultra vires dividend in cash and, despite knowing or having reasonable grounds to believe that the dividend was unlawful; the shareholder has chosen to retain the benefit of the money. In this case you could argue that the company has made a loan to the shareholder by virtue of ICTA88/S419 (2) thereby triggering a charge under ICTA88/S419 (1).

The ACT paid by the company in respect of the dividend would have been available for set-off against the Section 419 (1) charge with relief available under Section 419 (4) as and when repayment took place.

For additional information on ultra vires dividends see CTM20095 paragraphs 26 - 30.