What happens if you overpay company dividends?

When paying dividends to shareholders, the first thing a company’s directors should do is check how much profit is available to be distributed. But what happens if you have overpaid dividends?

Thanks to Louisa Drewett from Aardvark Accounting for answering our questions.

How do you know how much money can be paid as dividends at any one time?

We’ll go back to basics and start from the beginning. If you are considering making a dividend declaration on behalf of your company, you always need to consider what funds are actually available – and this requires a simple calculation – as follows:

Net Turnover (gross invoices, less VAT paid to HMRC) minus Expenses (such as salary, accountancy fees, travel & subsistence, subscriptions, computer consumables, etc).

This sum will provide you with the pre-tax profit figure. However, before paying dividends, you must consider the company’s tax liabilities first, so you must deduct Corporation Tax.

Corporation Tax is between 19% and 25% of the company’s profits. In the example below, the 19% rate applies.

Once you have deducted the taxes due, you will see the profit after tax figure.

Here is a simple example:

In the above scenario, £8,950 of profits are available to be distributed to the shareholders.

Is there a penalty if you take more dividends than profit available?

There isn’t a penalty as such…  However, as a director, you should know what profits are available to distribute to the company’s shareholders.

If dividends are taken in excess of available profits, these are usually known as ‘illegal dividends’.

You won’t be slapped in handcuffs, but it’s not advisable to keep ‘illegal dividends’ within the accounts; these can simply be corrected.

How can you correct overpaid dividends in your accounts?

Any excess dividends should be treated as loans to shareholders, which will then need to be repaid.

Assuming the recipient of the excess dividend is also a director of the company, then directors’ loan account benefit in kind implications have to be considered.

Providing all loans are less than £10,000 in the tax year and repaid within 9 months of the year-end, no benefit in kind or s455 charges will apply.

However, if the loan exceeds £10,000 at any point in the tax year and was provided either interest-free or below the official rate of interest, benefit in kind implications will apply.

If the loan remains outstanding more than nine months after the company year-end, s455 charges will apply to the remaining balance.

The charge would be in addition to corporation tax and 32.5% of the outstanding loan balance.

If the shareholder is not a company director, they may only be required to repay an illegal dividend if they know or have reasonable grounds for knowing that it was made illegally when the distribution was made.

To avoid sticky situations during the year, it’s worthwhile either preparing management accounts or using software that shows your company’s ‘real-time’ position so you can set aside enough for taxes and review the profit available for dividends.