Illegal Dividends: Avoid 33.75% Tax and Big Penalties

I Hate Numbers: Simplifying Tax and Accounting

Illegal dividends sound complicated, but we break them down in simple terms. In this episode, we share what counts as an illegal dividend, why they happen, and the steps you can take to avoid expensive problems. If you’re a company director or shareholder, this is essential listening.

What You’ll Learn in This Episode

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• What an illegal dividend is and why it matters.
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• The tax consequences for the company and directors.
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• How HMRC identifies illegal dividends.
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• Practical steps to stay compliant and stress-free.
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Illegal Dividends Explained

Under the Companies Act 2006, dividends can only be paid from accumulated, realised profits. If your company doesn’t have enough retained profits, paying a dividend is unlawful—even if your bank account looks healthy. It’s a common mistake, especially when cash and profit are confused.

Why Illegal Dividends Cause Problems

This isn’t just a technical breach—it can trigger serious tax consequences, increase insolvency risk, and create personal liability for directors. Think of it like driving without insurance. You may not get caught immediately, but if things go wrong, the impact can be huge.

Tax Consequences for the Company

If an illegal dividend is treated as a director’s loan and not repaid within nine months of the year-end, HMRC charges an additional tax of 33.75% on the amount. This applies even if the company is making a loss. While the charge is refundable if repaid later, the wait is long and the cost can hurt cash flow.

Tax Consequences for Directors

Directors can face extra tax on loans over £10,000, including a benefit-in-kind charge and Class 1A NIC. If the loan is written off, it’s treated as additional income and taxed accordingly. In liquidation, illegal dividends can make directors personally liable for repayment, creating serious financial risk.

How HMRC Identifies Illegal Dividends

HMRC uses digital filing and iXBRL-tagged accounts to check for inconsistencies between reserves and declared dividends. If your accounts show negative reserves but dividends paid out, expect questions. This is an easy red flag for HMRC systems.

Steps to Stay Compliant

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• Check retained profits before declaring dividends.
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• Don’t confuse cash with profitability.
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• Keep management accounts up to date using software like Xero.
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• Consult your accountant if unsure.
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• Repay unlawful dividends quickly if you make a mistake.
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Key Takeaways

Illegal dividends aren’t worth the risk. Review your dividend policy, maintain accurate records, and seek advice when in doubt. Avoid unnecessary tax charges and personal liability by staying compliant and proactive.

Links Mentioned in This Episode

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• 🔗 Book a Call
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Episode Timecodes

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• [00:00:00] – Intro: Why illegal dividends matter
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• [00:01:00] – What is an illegal dividend?
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• [00:02:13] – Why they create problems
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• [00:03:09] – Tax consequences for companies
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• [00:04:35] – Tax consequences for directors
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• [00:06:25] – HMRC checks and red flags
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• [00:07:07] – Steps to avoid trouble
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• [00:08:25] – FAQs and final advice
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Additional Links

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• 🔗 I Hate Numbers YouTube Channel
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• 🔗 Buy the I Hate Numbers Book
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