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 currently between 19% and 25% of the company’s profits, depending on profit levels and associated companies.

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.

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You can also read our guide to how dividends work in a limited company for a broader overview.

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 leave illegal dividends sitting in the accounts. They should be corrected.

How can you correct overpaid dividends in your accounts?

Any excess dividends are usually 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 director’s loan account implications have to be considered.

Providing the total loan balance is less than £10,000 at any point in the tax year and repaid within 9 months of the year-end, no benefit in kind or s455 charge will usually apply.

However:

• If the loan exceeds £10,000 and is interest-free (or below HMRC’s official rate), a benefit in kind charge arises
• If the loan remains outstanding more than 9 months after the year-end, an s455 tax charge applies

The s455 charge is currently 33.75% of the outstanding loan balance.

If the shareholder is not a company director, they may be required to repay an illegal dividend only if they knew, or had reasonable grounds to know, that it was made improperly at the time.

To avoid issues during the year, it’s worthwhile preparing management accounts or using accounting software that shows your company’s position in real time. This makes it easier to set aside enough for tax and confirm how much profit is available for dividends.