Illegal Dividends: Why Money in the Bank Isn't the Same as Profit You Can Pay Out

A lot of directors declare a dividend the same way: they check the business bank balance, see a healthy number sitting there, and pay themselves out of it. That's the single most common route into an unlawful dividend, and most directors who do it have no idea they've done anything wrong until an accountant or HMRC flags it months later.

Bank balance and distributable profit are not the same thing, and the gap between them is exactly where this goes wrong.

What actually makes a dividend lawful

Under section 830 of the Companies Act 2006, a company can only pay a dividend out of "profits available for distribution." That's defined as accumulated, realised profits, not previously distributed or capitalised, less accumulated, realised losses. It's a running total going back to incorporation, not just this year's profit, and it has nothing to do with how much cash happens to be sitting in the current account.

A company can be cash-rich and profit-poor at the same time. Think of a business that took a large deposit from a client for work it hasn't delivered yet, or one that borrowed to cover a VAT bill. The bank balance looks fine. The distributable reserves might not exist at all.

Interim dividends need interim accounts

Most small company dividends are interim dividends, paid during the year rather than after the annual accounts are finalised. The law expects you to justify that decision with "interim accounts" showing the company's financial position at the time, not just a gut feeling that things look okay. In practice, for a small company this usually means reasonably up-to-date management accounts: a profit and loss and a balance sheet that actually reflect reserves at the point you're declaring the dividend, not last year's year-end figures rolled forward on a guess.

If those management accounts don't exist, or haven't been looked at since the last set of annual accounts, you don't have a defensible basis for the dividend. That's true even if the dividend later turns out to have been fine in hindsight.

The paperwork isn't optional either

Two documents need to exist for every dividend payment, and they need to exist at the time, not reconstructed six months later when a mortgage lender or an HMRC enquiry asks for them.

Board minutes, recording that the directors met (or that a sole director made the decision) and formally resolved to declare a dividend of a specific amount per share, on a specific date. A dividend voucher for each shareholder, showing the company name and registered address, the shareholder's name, the class and number of shares held, the amount paid, and the date. The voucher is also what the shareholder needs to complete their Self Assessment return correctly.

Backdating either of these after the fact doesn't fix a dividend that was declared without proper authorisation. It just means you now have inaccurate paperwork describing an unlawful payment, which tends to make things worse rather than better if anyone ever checks.

What happens if you get it wrong

If a dividend is paid without sufficient distributable profits, it's unlawful regardless of whether anyone intended to break any rules. The consequences land in a few places at once.

A shareholder who knew, or had reasonable grounds to know, that the dividend wasn't properly covered can be required to repay it to the company. As a director of a small company, you're very rarely going to be able to argue you didn't know your own company's financial position, so this usually applies.

Directors can also be personally liable for breach of duty if they authorised a payment they should have known the company couldn't support, separately from whatever happens to the shareholder side of things.

And this is the part that catches people out most often: HMRC doesn't treat an unlawful dividend as a dividend at all. If there weren't enough profits to cover it, HMRC's starting position is that the payment gets reclassified as a loan to the director instead. That pulls it straight into director's loan account territory, with all the consequences that come with it: if it's not cleared within nine months and one day of the company's year end, the company faces a Section 455 tax charge on the outstanding balance, currently 33.75%, rising to 35.75% for loans made on or after 6 April 2026. If the reclassified loan sits above £10,000 without interest being charged, it can also trigger a benefit-in-kind charge, assessed against HMRC's official rate of interest, set at 3.75% from April 2026.

In other words, the dividend you thought you'd paid yourself tax-efficiently can turn into the exact thing you were trying to avoid.

How to put it right

If you've already paid a dividend that turns out not to have been covered by distributable profits, the usual fix is to formally reverse it and treat the amount as a director's loan from that point. From there you're either repaying it in cash, or waiting until the company genuinely has distributable profits and declaring a proper dividend that can be set off against the loan balance. What doesn't work is quietly leaving it as "dividends" in the books and hoping nobody looks closely. The books and the legal reality need to match.

If the error gets caught early, before the nine-month deadline for the accounting period in question, there's usually a way through without a Section 455 charge ever applying. Caught late, after the deadline's passed, the tax charge has usually already landed, and the company has to wait until the loan is repaid to reclaim it.

Checking before you declare, not after

The habit that actually prevents this is simple to describe and easy to skip when you're busy: look at genuinely current management accounts before you declare a dividend, not the bank balance and not last year's set of accounts. If the reserves aren't there, the dividend waits.

This is one of the places where FoundersLedger is built to be the thing you check rather than the thing you reconstruct afterwards. Because your profit and loss and retained reserves update as you bookkeep, you can see whether a dividend is actually covered before you declare it, not after your accountant asks where the paperwork is. Declaring the dividend through the platform also generates the board minute and the shareholder voucher at the time, with the figures that were true on that date, so you're not trying to rebuild the audit trail months later from memory.

This article is correct to the best of our knowledge at the time of writing and reflects rates and thresholds for the 2026/27 tax year. It isn't financial or legal advice. Rules around distributable profits and director's loans are fact-specific, and if you're unsure whether a dividend was properly covered, talk to your accountant before you fix it yourself.