When is a dividend illegal?

Contractor's Question: I want to continue to ensure that dividends I take from my limited company are drawn legally amid reports that the taxman is aware that a growing number are unlawful. So what constitutes an illegal dividend, and is it possible to draw a dividend that, although lawful, is ill-advised?

Expert's Answer: There are two instances where a dividend payment is illegal. The first is where the relevant paperwork is not correctly drafted. To avoid this, limited company owners might take advice from an accountant or solicitor to ensure that the correct paperwork is drafted to declare the dividend and to get the bill resolution.

The second instance, which is the more typical example of where dividends are unlawful, is where there is not sufficient retained profits in the company to pay the dividend. The same can be said for director loans, in that the loan taken out would be deemed illegal because it effectively makes the company insolvent.

The trouble is that until you administer the company's full accounts, you can't be absolutely certain that the dividend is foolproof. It follows that an ill-advised dividend would likely be paid where a company is starting to struggle for cash. For a company in such a situation, it is recommended to get the company's accounts up to date first before looking at the size of dividend that you can declare. At this assessment stage, you need to ensure that the dividend, due to its value/size, will not prohibit you from paying creditors, because you can't leave the creditors unpaid and still take money out of the company for yourself.

The expert was Keith Stevens, partner of Wilkins Kennedy.