The payment of dividends is generally a good indicator of the financial health of a business. Dividends represent a way of returning income on an investment (particularly for public and larger private companies), but that is not all they are used for.
Most companies in the UK are SMEs, a significant proportion of which are owner managed. In such companies the payment of dividends is used as a supplement to a nominal salary. Under UK company law there are specific requirements to allow for the payment of dividends. In this time of Coronavirus, where there is an almighty strain on cashflow, it is critical that companies are not found to be falling foul of these requirements.
This article assesses the law concerning the payment of dividends in SMEs and what considerations should be at the forefront of director and shareholder thinking.
Can you make a distribution?
There are two central tenets of making distribution to the shareholders of a company.
- Is there enough money?
- Can the payment be justified?
Both these questions relate to the state of the company accounts. In answer to the first question, the directors need to consider the company’s distributable reserves/profits. The legislation calculates this as being realised profits that have not already been distributed or capitalised less the company’s realised losses that have not been written off or where capital has been reorganised. If this calculation is in the positive, then a dividend might be possible. This is only the first step however.
The second step is that the dividend needs to be justified by reference to the relevant accounts. The first point to note is that the accounts are individual company accounts so directors must not consider group accounts. Generally, the relevant accounts are the most recent set of annual accounts, but there are instances in which interim accounts can be used. A further key point concerning the justification of the payment of a dividend connects to events following the production of the accounts. Points of consideration are as follows:
- Are the profits stated still relevant?
- Have any profits been depleted by subsequent losses?
- Will the dividend payment jeopardise the solvency of the company?
Considering the current pandemic, almost all sectors have seen a curtailing of their business and their cashflow. Directors will therefore need to consider thoughtfully the efficacy and legitimacy of making a distribution. Where directors decide that a distribution is appropriate it is essential that the decision-making process is adequately and appropriately recorded and evidenced.
Directors are subject to several duties of which they must take heed. Safeguarding company assets and having regard for the success of the company are two significant duties concerning dividends. Where directors fail to exercise these duties, they could be held personally liable for distributions made unlawfully (e.g. where there weren’t enough distributable profits).
Where directors decide that a distribution is appropriate there are other considerations that need to be considered.
Articles of Association
Prior to any recommendation or declaration being made the directors should consider the company’s articles of association for any company specific provisions relating to dividends. More importantly directors should determine whether there are specific restrictions on the payment of dividends.
If a final dividend, articles of association for private companies normally provide that they can be declared using a written resolution of the members.
It an interim dividend the articles of association may outline that the directors can resolve to pay the dividends.
Connected to the articles of association are the rights attaching to the shares in issue. Consider whether all shares have a right to receive dividends and whether there is a prescribed rate of dividend attaching to a specific class of share.
Register of members
Those shareholders entitled to a dividend are those members who are on the register of members at the time the declaration is made to pay a dividend. As such, it is important your company administration is up-to-date.
The above details instances where the directors and shareholders are different beings. There is, however, a question concerning situations where the director and the shareholder are the same person and the payment of a dividend is used to supplement an owner-director’s nominal wage. If the owner-director can resolve that the company has enough distributable reserves and the director can justify the payment with consideration given to the current economic downturn as a result of the pandemic, then such payment mechanisms can still be used, provided the company documents the payment correctly.
But what if dividend payments can’t be made?
The government’s Coronavirus Job Retention Scheme (the “Scheme”) is only available for employers operating a PAYE scheme, therefore the payment of dividends is not covered under the Scheme. However, a significant proportion of business owners of small enterprises rely on dividend payments since the success of the company correlates to the business coming through the door meaning a fixed salary is not conducive to this business size or model. At this time, there is no such scheme for small business owners but relevant bodies, like the Institute of Directors, continue to lobby the government to support business owners in this situation.