As a director you are probably advised to pay yourself a nominal salary with the balance of your remuneration package being paid by way of dividend. This is perfectly sensible. It reduces the tax burden and improves cash flow. However, what happens if you draw dividends when there are insufficient reserves?
There has been a long-running debate on whether dividends are unlawful when there are insufficient reserves to cover them. Some commentators (like me) always took the view if a director followed independent and professional advice and the payment of dividends was a tax-efficient way of paying remuneration then it should be fine. Indeed, in recent years court decisions on various matters (such as wrongful trading or malpractice) have generally looked at the position and adopted the view if a person took independent advice and followed it then they have done what any reasonable diligent person is expected to do, irrespective of whether that advice is flawed.
The above approach was continued in a case that was brought before the court where a sole director had drawn some £23,000 in dividends over a financial year. The company went into liquidation with a deficiency in excess of £173,000. It was recognised the director took independent advice and acknowledged if there were insufficient reserves then he would have to adjust his remuneration back to salary and account to HMRC for the PAYE/NIC as appropriate. The court adopted a practical, common sense opinion and the claim against the director was dismissed. The Applicant (who had “Purchased” the action from the liquidator) appealed.
In Global Corporate –v- Hale  EWHC(Ch) the appeal over-turned the earlier decision, saying,
“If it looks like a dividend and sounds like a dividend, it is a dividend.”
The court of appeal added further clarification in order to clear the waters muddied by the High Court by reaffirming:
- Companies must have sufficient reserves to pay dividends at the time they pay them, whether or not they intend to rectify any deficiency at the end of a tax year;
- Quantum meruitwill not act as a defence or set off to claims made by companies against their directors;
Personally, this decision does not sit well. After all, in some cases directors may have been taking dividends when something that could not have been reasonably envisaged extinguishes the reserves, automatically making those dividends unlawful. That, to me, is using the benefit of hindsight, something the courts have frowned heavily upon in the past, making the Global decision a little contradictory. I am sure there will be some that disagree with me on this but is that not what freedom of opinion is all about?
Should you have an insolvency-related issue or a corporate dispute then please contact Gary Pettit at PBC Business Recovery & Insolvency on (01604) 212150 (Northampton office) or (01234) 834886 (Bedford office). Alternatively, you may send an email to firstname.lastname@example.org or access our website at www.pbcbusinessrecovery.co.uk