Following the success of the taxpayer in the Husband and Wife Arctic systems case, apart from HMRC taking it to appeal at the House of Lords, they may focus more on other areas of attack for these and other family businesses.

Traditionally, dividends have often been used instead of salaries and bonuses to extract funds from the family company, largely due to the national insurance saving. This is very typical of both the Husband and Wife company, but also many owner managed companies.

If HMRC can show what has been paid out as a dividend was not paid legally, this gives them another line of attack. The potential tax implications of unlawful dividends include the the dividend being treated as void and the shareholder liable to repay the dividend to the company and so deemed to hold the funds as constructive trustee for the company. In most cases HMRC would argue that the funds therefore represent a loan to a participator, on which the company is liable to a tax charge of 25%. Relief is available if the dividend is subsequently repaid.

It is therefore important to ensure that dividends are paid legally. HMRC may well request and examine the documentation relating to family company dividends. All the paperwork such as dividend resolutions and vouchers should be in place and other requirements of the Companies Act met.

Interim and Final Dividends
The company’s Memorandum and Articles of Association should show who is authorised to declare a dividend and most modern company articles allow directors to declare dividends from time to time. If not, dividends are payable only when declared by an ordinary resolution passed by the shareholders in general meeting.

There is a difference between interim dividend and final dividends. Interim dividends are legally due and payable when actually paid. A resolution to pay an interim dividend can be varied or rescinded, and therefore the resolution does not create a debt until the dividend is paid. Final dividends should usually be recommended by the directors and approved by the shareholders in ordinary general meeting. Final dividends are legally due when declared unless a later date for payment is specified, in which case they are due on that payment date.

The dividend payment date can be important. For example, if the business owners have withdrawn funds ‘on account’ of dividends being paid, this results in an overdrawn director’s loan account on which there is both a benefit in kind on the interest free loan as well as the potential 25% tax charge. Dividends may be declared to clear the overdrawn loan account but in the case of interim dividends being credited to the loan account, HMRC consider that payment is not made until an entry is made in the company’s books. This entry could arise in a later accounting period than the directors’ resolution to pay the interim dividend. The physical payment of dividends to shareholders immediately after their declaration, followed by the re-introduction of those funds to the company with a corresponding credit to the director’s loan account, should help to put the issue beyond dispute.

Paying Dividends Out of Profits
Before declaring an interim dividend, the directors must be satisfied that the company has sufficient profits to cover the dividend. This will normally be by reference to the company’s last annual accounts, except where those accounts show insufficient reserves to legally declare the dividend. ‘Interim accounts’ may be required in those situations. In the case of new companies intending to pay an interim dividend in the first accounting period, ‘initial accounts’ may be appropriate.

For owner-managed businesses in particular, problems often arise when interim dividends are paid during the accounting period. When accounts are subsequently prepared for that period, it may transpire that the company had insufficient distributable reserves to cover the dividend.

We can of course assist you with putting the right paperwork in place and with assistance with the necessary interim accounts.

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