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HMRC internal manual

Company Taxation Manual

ACT: General: Notes on company law aspects of dividends

Dividends, ICTA88/S209 (2)(a)

  1. The Companies Acts do not provide who shall declare a dividend and, in particular, do not require the dividend to be declared by the shareholders in general meeting. It is possible to lay down in the 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 provide that dividends are not to be declared by an ordinary resolution passed by the shareholders in general meeting, the directors, under their general powers, will be entitled to declare a dividend without the sanction of a general meeting.

  2. 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.

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

   i) final dividends may be declared by the company in general meeting but no dividend shall exceed the amount recommended by the directors (Article 102 Table A 1985 Regulations), and 

   ii) interim dividends may be paid by directors from time to time (Article 103 Table A 1985 Regulations).

  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 paragraphs 16 to 25 below concerning profits available for distribution and paragraphs 26 to 30 below concerning ‘ultra vires’ distributions). The general meeting cannot interfere with the directors’ exercise of their power to pay interim dividends (see Potel v CIR [1971] 2AER504). 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the payment of interim dividends by directors, a resolution by the board to pay an interim dividend can be varied or rescinded at a later meeting of the board (see Potel v CIR and paragraph 9 below concerning when a dividend is due and payable). In addition, the dividend will be reflected in the accounts, and the shareholders must approve the accounts themselves.

When is a dividend paid?

  1. ICTA88/S209 (2)(a) includes in the definition of “distribution” any dividend paid by the company. ICTA88/S843 (3) adds a little gloss to this by saying that “For all 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 at paragraph 9 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.

  2. One view of Section 209 (2)(a) and Section 834 (3) is that they work together to treat a dividend as paid on the date it becomes due and payable. On this interpretation the object of Section 834 (3) was to ensure that the Revenue received its ACT on the due and payable date even if actual payment of the dividend was not made until later.

  3. It is considered that the purpose of Section 834 (3) is not to deem as “paid”, dividends that would not otherwise be paid, but rather, once a dividend has been paid, Section 834 (3) fixes the date that is to be treated as the date of payment by reference to the “due and payable” date. A waived dividend cannot, therefore, be regarded as “paid” for the purpose of Section 209 (2)(a).

  4. A dividend is not paid and there is no distribution, unless and until the shareholder receives money or the distribution is otherwise unreservedly put at their disposal, perhaps by being credited to a loan account on which the shareholder has the power to draw. The company was not required to include the dividend on its CT61 nor account for any ACT until the dividend had actually been “paid”. When payment did take place a return had to be made and ACT accounted for as if the dividend had been paid at the earlier due and payable date. This fixed the rate of ACT. Interest on ACT was also due under TMA70/S87 on the basis that the dividend was paid at the earlier due and payable date.

When is a dividend due and payable?

9.This largely depends upon what powers the company relies on in paying its dividends. As discussed at paragraph 3 above, it is nowadays usual to find companies’ articles providing that:

   i) final dividends may be declared by the company in general meeting, and

   ii) interim dividends may be paid by directors from time to time.

The significance of this in the 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, can be varied or rescinded at any time before payment and can therefore only be regarded as “due and payable” when it is actually paid. Potel v CIR 46TC658 contains a clear exposition of this point, particularly at page 669.

What is meant by “payment”?

  1. 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] 2KB584). 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] 2KB509).

  2. 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 can take no steps to enforce payment until the due date of payment (or payments if by fixed instalments, see Potel v CIR). The “due and payable” date in such circumstances is the date fixed for payment and not the date of declaration.

  3. In many small private companies the directors and shareholders are one and the same, and dividends are often credited to the directors/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.

  4. In the case of an interim dividend (which 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/shareholders as part of their current accounts with the company. So, payment is not made until such a right to draw on the dividend exists (presumably) when the appropriate entries are made in the company’s books.

  5. If, as may happen with a small company, such entries are not made until the annual audit, 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

  1. At common law there is a basic general principle that dividends must not be paid out of capital even if the Memorandum or Articles of a company authorise such a payment. Part VIII of the Companies Act 1985 has largely replaced this principle. The overriding principle now is that a dividend or distribution to shareholders may only be made out of profits available for the purpose. A statutory code of profits in the legal sense appears in Sections 263 to 281 of the Companies Act. In general, the new rules do not distinguish between capital and revenue profits but rather concentrate on the difference between realised and unrealised profits. All calculations for profits available for distribution must be taken from the “relevant accounts”.

The relevant accounts

  1. Section 270 Companies Act 1985 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.

  2. 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”. Firstly, 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 270 (4)(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 270 (4)(b)). There are therefore three types of relevant accounts:

   i) - the last annual accounts, that is the standard accounts prepared annually under the Act (Section 271),

   ii) - interim accounts (Section 272),

   iii) - 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 273). Where the last annual accounts are the only relevant accounts, the following three statutory requirements (Section 271) must be complied with:

    i) 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” or prepared to such an extent that the matters outstanding are not material to the determination of the legality of a distribution,

   ii) there must have been an auditors’ report under Section 236 (subject to the usual exemptions from the audit requirement for certain companies),

   iii) 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 272) must be complied with by public companies:

    i) 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,

    ii) a copy of the accounts must have been delivered to the Registrar of Companies,

   iii) 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 273) must be complied with by public companies:

   i) the accounts must have been properly prepared and signed in the same way as is required for interim accounts,

   ii) the auditor must have reported that the accounts were properly prepared,

   iii) if the auditors’ report is qualified, the auditors must state in writing whether the qualification is relevant to determining the legality of the distribution,

   iv) a copy of the accounts, the auditors’ report and any statement must have been delivered to the Registrar of Companies,

   v) 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 270(4). It follows that the format of those accounts may differ from the annual audited accounts submitted as part of the company’s return.

  1. Failure to comply with these requirements will mean that the distribution is unlawful (Section 270(5)). 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 at paragraphs 26 to 30 below. The shareholders cannot agree to waive the requirements of the Act (see Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] 1Ch447).

  2. 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 274 of the Companies Act, in determining the validity of the further distribution.

Determination of profits

  1. The Act lays down what can 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.

  2. Section 263 (3) Companies Act lays down the basic rule, but it does not apply to investment companies and is qualified in respect of public companies by Section 264. 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.

  3. 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 275 (2)).

  4. Under Section 275 (1) Companies Act, realised losses for the purpose of Section 263 include amounts written off or retained for depreciation.

Public companies

  1. It is not sufficient that a public company has available distributable profits under Section 263 Companies Act 1985. Section 264 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 can 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 as:

   i) the share premium account,

   ii) the capital redemption reserve,

   iii) the amount by which the company’s accumulated unrealised and uncapitalised profits exceed its accumulated unrealised losses not written off, and

   iv) any other reserves which the company is prohibited from distributing by statute or its Memorandum or Articles.

Dividends out of capital contribution

  1. A UK resident company may receive a “capital contribution” from a non-resident parent company out of which the subsidiary pays a dividend to its parent. All cases involving capital contributions should be submitted to International.

Ultra vires and illegal dividends

  1. The question of whether a dividend is unlawful or not is not a tax matter. 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. You 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 device.

  2. There is a significant difference in the treatment of improperly paid dividends dependent upon the position of the recipient. Section 277 Companies Act 1985 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.

  3. 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] 25ChD752 and Moxham v Grant [1990] 1QB88. 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 his 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 our view that Section 277 Companies Act 1985 will apply in the majority of such cases.

  4. 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 Dillion 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 IT under ICTA88/S20 and ACT under ICTA88/S14 since 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 44TC at page 373). Where the company concerned is a close company, the company is regarded as having made a loan to the shareholder by virtue of ICTA88/S419 (2), thereby triggering a charge under ICTA88/S419 (1). Relief would however be available under Section 419 (4) 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.

  5. Where the shareholder had no knowledge of the illegality of the dividend and no reasonable grounds on which to so believe then he is not a constructive trustee. In such circumstances the shareholder does not have to repay the dividend that will constitute a distribution under ICTA88/S209 (2)(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 ACT/higher rate position. However, in practice it would be desirable to consider all such cases on their particular facts and merits.

Dividend waivers

  1. 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 Part XV ICTA 1988. A waiver properly made before payment involves more formality than a simple request not to pay dividends or to pay them elsewhere. As discussed at paragraphs 7 and 8 above, we consider that 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.

  2. As discussed in paragraph 8 above, ACT liability 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

  1. Prior to 6 April 1999, 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 to the Revenue 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 The 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 the latter 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 The 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, and 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.