Returns of value to shareholders - legal considerations of paying a dividend
20 March 2018
A dividend is a distribution to shareholders of a company’s post-tax profits. Dividends are usually paid in cash, but can also be satisfied by the transfer of other assets, such as property or shares (known as a dividend in specie) or by the issue of new shares in the company (a SCRIP dividend). Dividends are generally considered to be a tax efficient mechanism for returning value to shareholders, as they are taxed at a lower rate than income tax.
However, changes proposed in last year’s Spring budget, which are due to be introduced in April 2018, see a reduction in the tax fee allowance on dividends. As such, whilst dividends still potentially offer a more tax efficient way of obtaining income from a business in comparison to income tax, any potential dividend income ought to be considered by individual shareholders as part of their wider tax planning, rather than being considered in isolation.
Dividends are often divided into “final” and “interim” dividends, with final dividends being paid annually following the end of the company’s financial year, and interim dividends being paid at any time throughout the financial year.
When considering whether to pay a dividend, the following criteria should be considered and satisfied:
The company must have “distributable profits” available (section 830(1) of the Companies Act 2006 (‘CA 2006’)). This is defined as a company’s “accumulated, realised profits (so far as not previously utilised by distribution or capitalisation) less its accumulated, realised losses (so far as not previous written off in a reduction or reorganisation of capital)”.
The distribution must be justified by reference to the “relevant accounts” of the company (ss. 836 – 839 CA 2006). These are always the Company’s individual accounts (as opposed to the group accounts, if any) and are usually the company’s most recent annual accounts. However, specially prepared interim accounts may also be used.
The provisions of the company’s articles of association should be checked to determine how dividends should be declared. Typically, final dividends are recommended by directors but declared by the shareholders, whereas interim dividends are often declared by directors alone.
The provisions of any shareholders agreement or investment agreements should also be checked. These types of agreement will often set out a policy as to how and when dividends should be declared (and whether shareholder approval is required).
If there is a loan or facility in place, the provisions of the facility agreement should be checked. The facility agreement may contain a covenant preventing the payment of dividends, or may specify that lender consent is required. Alternatively, it may be that an amendment to the agreement can be negotiated. Similarly, if the facility is secured, any future dividends may be covered by the security, and the debenture or other security documents should also be reviewed. It may be that the security will need to be partially released or the security documentation amended before a dividend can be declared.
Finally, the directors should consider their statutory duties to the company under the CA 2006. In particular, directors have a duty to act within their powers (section 171), to promote the success of the company (section 172) and to act with reasonable care, skill and diligence (section 174). Similarly, if the directors are also shareholders of the company (and therefore likely to benefit personally from the payment of the dividend), that may be a conflict of interest. This interest may need to be declared in accordance with the provisions of section 175, 177 and/or section182 of the CA 2006.
The consequences of authorising a dividend in contravention of the Companies Act 2006 can be serious, particularly for directors, who may be found personally liable if there were insufficient distributable profits to justify the dividend. Similarly, a director could also be liable under the Insolvency Act 1986 if the company was insolvent at the time of payment and there were no reasonable grounds for believing that the dividend payment would benefit the company. It is therefore fundamental that the above matters are considered carefully before a dividend is authorised.
We would always advise that the directors keep clear records of any board or general meetings authorising dividends, documenting the position in relation to the distributable profits of the company and setting out the justification for the dividend (with reference to the relevant accounts).
If there are any other legal documents in place (such as shareholders or facility agreements) you should also consider getting legal advice as to the ability to pay or authorise a dividend under the terms of those documents.
Hayleigh Sears on Tuesday, 20 March, 2018 · Leave a comment