In the current harsh economic climate, many companies are making losses.

It is very common to find small companies paying modest salaries to the director / owners and also paying dividends, this is the most tax efficient way to extract profits from the company.

If the company is making losses then be aware that paying dividends could be dangerous! Dividends need to be paid from available profits – this could be profit earned this year or profits earned in earlier years but retained in the company rather than paid out as dividends.

Pay a dividend when there are no available profits and this is ‘ultra vires’ or invalid, this can have the following nasty consequences:

Firstly, the shareholders can be required to repay the invalid dividend to the company. This can happen after the company has gone into liquidation, and can be a very unexpected and financially painful experience.

Secondly, the Inland Revenue will treat the invalid dividend as a loan to a participator. Where such a loan is outstanding more than 9 months after the end of an accounting period, there is a tax charge of 25% on the value of the loan. This is commonly known as S419 tax (S419 ICTA 1988 is the legislation). There is also a tax charge on the benefit of an interest free loan (unless the amount of the loan is below £5,000)