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News & Portal: Tax

Unlawful dividends: What are the consequences?

24 April 2020  
Posted by: Bloomsbury Professional
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By Peter Rayney for Bloomsbury Professional

A relatively common occurrence in family or owner-managed companies is the inadvertent payment of unlawful dividends. If a company’s dividend exceeds its distributable reserves, this will be an unlawful distribution and the company may be able to obtain repayment from the shareholder recipient.

Company law position

Where a shareholder knows or has reasonable grounds for believing that a dividend is illegal (e.g. due to the lack of sufficient distributable profits), CA 2006, s 847 provides that they are liable to pay it back to the company.

The Court of Appeal held that an unlawful distribution received by the company’s holding company (which knew the facts) was liable to be repaid (Precision Dippings Ltd v Precision Dipping Marketing Ltd [1986] Ch 447). Consequently, where a shareholder knowingly receives an illegal dividend, it is certainly arguable that they hold the cash received as a ‘constructive trustee’ for the company since they are liable to repay it (or such part of it that is unlawful). Similar issues can arise where assets are transferred to a ‘related’ company at an undervalue.

Tax implications

The legal analysis of an unlawful distribution is usually followed for tax purposes. HMRC often argues that an ‘unlawful dividend’ represents a loan to the relevant shareholder(s), which may be subject to a CTA 2010, s 455 charge. This is likely to be the case for the majority of unlawful distributions made by family and owner-managed companies.

In It’s a Wrap (UK) Ltd v Gula [2006] EWCA Civ 544, unlawful dividends paid to members as ‘quasi-salaries’ (on the advice of their accountant to save tax!) were found on appeal to be repayable by the shareholders. Although they were unaware of the illegality, it was held that a shareholder was liable to return a distribution if they knew or should have been aware that it had been paid in circumstances which amounted to a contravention of the restrictions on distributions (irrespective of whether or not they knew of those restrictions). Shareholders who are also directors of the company will therefore find it very difficult to escape liability under these rules.

The company’s director(s) may also be personally liable for any improper distributions as this may amount to a breach of their common law fiduciary duty and/or their statutory duties imposed by CA 2006.

Cash and in specie dividends

A dividend can either be paid in cash or in specie. Generally, dividends can only be paid in cash, whereas an in specie dividend (which involves the transfer of a specific asset) requires express authority in the Articles (this is given in Article 105 of Table A). It is, of course, possible for the Articles to be amended by a special resolution where the relevant authority is not available (note that the pre-1948 versions of Table A do not contain this power).

Before making an in-specie distribution, it is important to ensure that the company’s articles contain the necessary power for it do so. It is normally preferable for in-specie distributions to be made as interim ‘dividends’.

Unless the company is being made as part of a winding-up, the distributing company must have sufficient distributable reserves to distribute the ‘accounts’ carrying cost of the properties/other assets. In such cases, CA 2006, s 846 enables any revaluation surplus actually ‘booked’ in the accounts in respect of the distributed asset to be treated as distributable. Where no revaluation surplus is ‘credited’ in the accounts, only the ‘carrying cost’ (or value) of the asset recorded in the accounts would have to be met from the company’s reserves. This principle is particularly important in determining whether the company has sufficient reserves to be able to facilitate a statutory demerger, which involves an in-specie distribution of shares in a 75% subsidiary or trade and assets.

It may be necessary to prepare management accounts to enable the directors to be satisfied that the distribution can be validly made.

Distributions of land and property

An in specie distribution of an asset to a shareholder would involve a ‘market value’ disposal by the company for capital gains purposes (TCGA 1992, s 17(1)).

As a general rule, land and property (in, say, London) distributed in specie should not attract any SDLT since it is being made for no consideration (FA 2003, Sch 3, para 1 – note the override to the ‘market value’ rule in FA 2003, s 54(4)).

It is often desirable to transfer properties to the parent company as a distribution in specie, since this avoids the need to rely on the SDLT group relief provisions and its associated anti-avoidance and clawback provisions (FA 2003, Sch 7, paras 1–6). However, an SDLT charge based on the market value of the land/property will apply where the company making the distribution had previously received the relevant land/property under the SDLT group relief provisions in the past three years (FA 2003, s 54(4)(b)).

In contrast, an SDLT charge would arise where the property is distributed in specie to a shareholder who also assumes (third party) debt/mortgage attaching to the property. In such cases, the SDLT charged is based on the value of the debt/mortgage assumed (as opposed to the market value of the property).

If the novated debt is owed to the recipient shareholder and the distribution is being made to them as part of a winding up, HMRC agree that there is no effective consideration and hence no SDLT is charged (see HMRC’s SDLT Manual at SDLTM04043). On the other hand, HMRC might use the general SDLT anti-avoidance rule in FA 2003, s 75A to levy SDLT where the shareholder injects cash into the company (via shares/loan account) to repay third party debt before the liquidation.


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