Monthly dividends - Large unexpected invoice

[jones87]

Hello,

A company is profitable and dividends are paid monthly out of profit. Due to unexpected legal action against the company, a very hefty legal bill and damages have to be paid out, this immediately puts the company into a loss as the bill is so large and unexpected. This is all inside 1 tax year.

This means that the company is NOW not in profit, but what happens to all those dividends paid out for the last 10 months?

It's a tricky situation as the company has always shown healthy cash flow and good profits each month, before dividends have been taken out, so they have followed the rules so to speak, however the legal action against the company was so unexpected.

Thanks in advance for your help..:redface:

 

[Spongebob]

A pertinant question; and one that could just as well be asked if a company suddenly experiences a downturn in fortunes halfway through the year as a result of illness, competition, or whatever.

Now that every window cleaner and dog walker is operating as a limited company, paying themselves the NI minimum, and topping up with 'dividends' on the advice of their accountant, this conundrum needs to be thought through.

My solution would be not to account for payments until the year end, and then make the decision on whether to classify them as dividends, salary, bonus, or directors loan as appropriate. I would be interested to know what our accountants' view of this would be...

 

[Williams lester]

A pertinant question; and one that could just as well be asked if a company suddenly experiences a downturn in fortunes halfway through the year as a result of illness, competition, or whatever.

Now that every window cleaner and dog walker is operating as a limited company, paying themselves the NI minimum, and topping up with 'dividends' on the advice of their accountant, this conundrum needs to be thought through.

I would be interested to know what our accountants' view of this would be...

If the dividends are legal at the time they are paid out, then no problem, director's just need to ensure that they have management accounts showing a profit at that point and that there are board minutes relating to the distribution.

Have a look here for the ACCA guidance on this http://www.accaglobal.com/uk/members/technical/financial_reporting/guidance/dividends

 

[Spongebob]

If the dividends are legal at the time they are paid out, then no problem, director's just need to ensure that they have management accounts showing a profit at that point and that there are board minutes relating to the distribution.

Interesting...

So in the result of a company going insolvent, all you'd have to do to substantiate any dividends paid earlier in the year would be to produce from your briefcase some management accounts showing a profit at that time, together with minutes of a 'board meeting'.

 

[David Griffiths]

Interesting...

So in the result of a company going insolvent, all you'd have to do to substantiate any dividends paid earlier in the year would be to produce from your briefcase some management accounts showing a profit at that time, together with minutes of a 'board meeting'.

Exactly. We've had precisely that experience with a company that got hit by a large claim and was forced into liquidation. The liquidator fixed his beady eyes on the dividends paid out in the early part of the year, but we were able to demonstrate that the dividends were legal when declared, and that they were properly declared by a meeting of directors.

Too many companies don't declare the dividends properly and sort everything out in arrears - that is quite dangerous, and open to attack on a couple of fronts. Our systems mean that we contact clients quarterly and prepare the paperwork for them.

 

[jones87]

Exactly. We've had precisely that experience with a company that got hit by a large claim and was forced into liquidation. The liquidator fixed his beady eyes on the dividends paid out in the early part of the year, but we were able to demonstrate that the dividends were legal when declared, and that they were properly declared by a meeting of directors.

That is interesting and not the answer I was expecting to be honest, should the tax man inspect the accounts, providing the paperwork is in place this should not be a problem and there should not be any worries about the dividends having to be declared as PAYE instead at year end.

 

[Tom Egerton]

It's very unlikely that HMRC would seek to redefine dividends as remuneration. In cases where the paperwork is deficient, they sometimes try to redefine as directors' loans in order to claim the section 419 tax.

From what you've said and other posters advised there should be no problem. Only you know the size of the legal bill concerned but on the basis that it is "material" I'd show it as an extraordinary item on the P & L Account with an appropriate note.

 

[elliotgreen]

The problem here is the unexpected legal bill is at the time the dividends were taken is a contingent liability. Nothing is certain in litigation, there is always a risk that you could lose until judgement is handed down.

The risk to you now is the dividends are repayable by you to the company because the company although at the time apparently profitable, after making suitable provision for the litigation might not have been satisfied that there would have been sufficient distributable reserves available to it to validly declare the dividend.

 

[Tom Egerton]

Agree entirely with Elliot Green. In the event of liquidation, the insolvency practitioner would look at this sort of area and also whether certain creditors had been preferentially treated. The objective is to ensure that all creditors are treated fairly in any distribution.

I do find it hard to grasp that no indication of a potentially large liability existed on day 1 of the action. Large legal bills or claims for damages do not suddenly materialise since the first job of the legal representative is to give his client some idea of the potential "damage".

All of this is irrelevant if you are able to continue trading profitably and back into surpluses.

 

[jones87]

Thanks for your replies,

The damages would relate to copyright/passing off. If the directors paid themselves entirely by PAYE, do you think the salaries could still be claimed back if the company was wound down by the party claiming damages?

Thanks.

 

[elliotgreen]

You are less likely to be at risk had the payments been properly applied to the company's payroll.

If the company in insolvent then making payments to directors needs to be carefully considered so that the question of excessive remuneration does not raise its head.

 

[yorkshirejames]

Thanks for your replies,

The damages would relate to copyright/passing off. If the directors paid themselves entirely by PAYE, do you think the salaries could still be claimed back if the company was wound down by the party claiming damages?

Thanks.

An interesting question, and I agree with all other responses.

To answer this question: if the above were done properly, and there was a proper contract of employment etc etc, then no chance of being claimed back.

Re the main issue - I suggest the first question is whether you do in fact have management accounts and board minutes? If not (and do not even consider fabricating these after the event) then it may be that an accountant would advise considering these as salary (with appropriate monies owing to HMRC).

 

[jones87]

Re the main issue - I suggest the first question is whether you do in fact have management accounts and board minutes? If not (and do not even consider fabricating these after the event) then it may be that an accountant would advise considering these as salary (with appropriate monies owing to HMRC).

Should director's have a contract of employment with their own company? It's an interesting point and I never considered this.

Board minutes with signatures and vouchers have been produced each month, however management accounts we're not compiled. The decision to pay dividends was based on rough hand written notes, showing P/L, how much money was in the bank and what liabilities and outgoings we're expected. These rough notes usually ended up in the bin.

On another note, can anyone point me to a guide on management accounts? I think today would be a good day to start doing this properly.

 

[yorkshirejames]

Should director's have a contract of employment with their own company? It's an interesting point and I never considered this.

Depends whether they want the protection that being an employee offers, or want the opportunity to maximise their take home (use of dividends etc).

Management accounts - not for the feint hearted - start at http://www.cimaglobal.com perhaps.