Unlawful Dividends: What Directors Must Know

An unlawful dividend is one paid when the company does not have enough distributable profits to cover it. It can usually be put right, but the shareholder may have to repay it and HMRC may treat the money as a loan rather than dividend income. Most cases start the same way: a director takes regular "dividends" in a year that is quietly turning into a loss.

Key takeaways

• Dividends can only come from accumulated realised profits, not from cash in the bank.
• Check reserves with up-to-date management accounts before every interim dividend.
• A shareholder who knew the rules were broken can be made to repay the dividend.
• HMRC may treat a repayable dividend as a director's loan, with tax consequences.
• Act early: the fix is simpler before the year-end accounts are finalised.

What are distributable profits?

Section 830 of the Companies Act 2006 says a company may only make a distribution out of profits available for the purpose: its accumulated, realised profits, less its accumulated, realised losses. In a typical small company that is close to the retained earnings (profit and loss reserve) line on the balance sheet, after tax.

GOV.UK's guide to taking money out of a limited company puts the same rule plainly: you must not pay out more in dividends than your available profits from current and previous financial years. If you are not sure where to find that figure, our guide on reading a company balance sheet shows where it sits.

Interim and final dividends: who decides and when

Most owner-managed companies pay interim dividends, which the directors decide on during the year, usually at a board meeting recorded in minutes. A final dividend is recommended by the directors after the year end and approved by the shareholders once the accounts are ready. The legal test is the same for both, but the risk is not. A final dividend is checked against finished accounts, while an interim dividend relies on whatever figures the directors have at the time. That is why interim dividends taken on a fixed monthly pattern are where most problems start, and why we suggest a short reserves note in every set of interim minutes, saying which figures were used and what the available profit was on that date.

How unlawful dividends usually happen

Worked example: a year that turned

Illustrative example, invented figures, not a real client. A one-director consultancy has retained profits of £9,000 at its last year end, 31 March 2025. During 2025/26 the director takes interim dividends of £2,500 a month, £30,000 in total, while paying a small salary.

A major contract ends in the summer, and the year closes with a profit after tax of £12,000. Distributable profits available for the year are therefore £9,000 + £12,000 = £21,000. Dividends of £30,000 exceed that by £9,000, so £9,000 of the dividends were unlawful.

Because the director is also the only shareholder and approved every payment, they are treated as knowing the position. The £9,000 is repayable to the company. In practice it is commonly recorded as owed by the director through the director's loan account. If that balance is not repaid within nine months and one day of the year end, the company may face a temporary corporation tax charge on the loan; check the current rules on GOV.UK's directors' loans page. The other £21,000 was covered by profits and is treated as ordinary dividend income.

Had the director run a reserves check in September, when the contract ended, they could have stopped the payments at £21,000 and avoided the whole problem.

Step by step: what to do if you think it has happened

1. Stop further dividends straight away. Switch to salary or simply pause withdrawals until you know where you stand.
2. Prepare up-to-date figures. Accurate management accounts to the date of each dividend show exactly when reserves ran out. Our guide to management accounts explains what these include.
3. Quantify the excess. Compare total dividends with the profits available at the time each was paid.
4. Decide how the excess will be repaid. Options include paying it back in cash or recording it as owed to the company, then clearing it.
5. Get the paperwork right. Board minutes and dividend vouchers should match what actually happened.
6. Take advice on the tax treatment. HMRC's position on unlawful dividends is set out in its Company Taxation Manual, and the right answer depends on the facts and the paperwork.

Common mistakes

• Using the bank balance as the test. Cash and profits are different things; a VAT refund or customer deposit can make a loss-making company look rich.
• Forgetting corporation tax. Reserves should be measured after tax, or the dividend can quietly use money owed to HMRC.
• Backdating minutes to cover the gap. Documents must reflect what really happened. Recreating them later causes more problems than it solves.
• Leaving it to the year-end accounts. By then the loan account deadline may be close, and options are narrower.
• Assuming small companies are exempt. The rules apply to every private limited company, whatever its size.

How we can help

We prepare quarterly management figures so directors can see their distributable profits before they pay themselves, and we help put things right when a dividend has gone too far. Limited company packages start from £75/month and company accounts from £350/year. See our company accounts service, view our pricing, or contact us before your next dividend.