The short answer is yes – you can only normally pay dividends from distributable reserves (money left over after settling all costs and which the business can afford to pay).
However in a recent case of Global Corporate Ltd v Hale (2017) the judge decided that what the director thought was dividends could be treated as salary and so did not need to be repaid. This will give some problems to liquidators trying to recover illegal dividends.
What were the facts of the case?
The company traded as a vehicle tuning centre with two directors and shareholders. It went into insolvent liquidation in 2015. The defendant director had been paid a combination of a small salary and dividends of £1,383 per month.
Each month the director signed the forms for the payment of the monthly dividend. At the year end the company’s accountant would decide whether there had been sufficient profits or not to pay these dividends. In the final year of trading this year end ‘check’ was not done – as the company was in liquidation.
The liquidator tried to recover the illegal dividends.
The judge decided that the monthly payments could not be dividends until the year end when a decision could be made. Therefore they could be salary. He also said repaying these funds would have unjustly enriched the company as the director was effectively working for a reasonable sum. Without this money he would not have worked for the company.
My advice to directors is make sure they keep a proper record of payments taken, have the dividend forms completed as well and to make sure the amount they are taking is a fair and reasonable sum for the work they are doing.