18th March 2009
For some time it has been quite popular, and tax efficient, for directors/shareholders of limited companies to pay themselves a small salary but to take, in addition, a much larger amount by way of dividend.
In theory the dividend is paid at the financial year end when the profitability of the business is established. In practice many directors do not wait until the year end and they make regular weekly or monthly drawing by way of dividends.
This works fine when the company is profitable and when there are reserves available; but a problem arises when the business is affected by the economic downturn and big losses deplete any reserves.
In this event the payment of dividends is illegal in that it creates an overdrawn director’s loan account and funds need to be placed back into the company.
In an insolvency situation an overdrawn directors loan is regarded as an asset and it is our duty to realise it from the directors/shareholders; serious problems can be created when they are not forthcoming.
In a worse case scenario, and where directors are pursued for unpaid tax by HMRC, director shareholders could plead that they were acting on advice given by their accountant, leaving them left open to a challenge regarding the quality of the advice and the possibility of a claim made on them, either from their own client or from HMRC.
Accountants who have given such advice are advised to regularly review that their clients still retain distributable reserves and that the payment of dividends is still appropriate, thereby ensuring that this issue does not arise.
If there is any doubt about the availability of distributable reserves, the client should be advised to stop drawing dividends immediately and rejoin the PAYE payroll scheme.
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