Director owner companies in the UK are continuing to fall into the trap of drawing dividends even when distributable reserves aren’t there to take out profits.

The alarm call to hundreds of thousands of off-payroll freelancers has been sounded by Azets restructuring and recovery partner, Chris Tate.

Commenting on this, Tate said: “This has been an age-old trap whereby companies become accustomed to drawing a mix of dividends and salary so as to minimise their personal tax bill.

“While this is a validly commercial approach during good times, if trading performance takes a turn for the worse, the director owners can quickly fall into the trap of drawing dividends unlawfully which can be subsequently clawed back if the company cannot avoid formal insolvency.

“Following the recent uptick in formal insolvencies following the pandemic, we are coming across more cases of this than usual. This is particularly prevalent with Personal Service Companies – PSCs.

“Whilst self-employed contractors may well be excellent at the service they provide, some may well lack understanding about what they are legally entitled to take as dividends, especially if they rely on dividends instead of a PAYE salary for tax purposes, which includes not paying National Insurance contributions and not having tax deducted at source.

How well do you really know your competitors?

Access the most comprehensive Company Profiles on the market, powered by GlobalData. Save hours of research. Gain competitive edge.

Company Profile – free sample

Thank you!

Your download email will arrive shortly

Not ready to buy yet? Download a free sample

We are confident about the unique quality of our Company Profiles. However, we want you to make the most beneficial decision for your business, so we offer a free sample that you can download by submitting the below form

By GlobalData
Visit our Privacy Policy for more information about our services, how we may use, process and share your personal data, including information of your rights in respect of your personal data and how you can unsubscribe from future marketing communications. Our services are intended for corporate subscribers and you warrant that the email address submitted is your corporate email address.

“They are reliant on their professional advisors to warn them of such pitfalls. However professional advisors are often working on historic data and by the time the issue is identified, it is too late.

“The simple fact is that director shareholders are not entitled to dividends if distributable reserves on the annual balance sheet aren’t there to draw down on profits.

“In our digital age, there is no excuse for financial ignorance – the IT and software is available to provide real-time management information. Failing that, the director should be able to pull off manual monthly reports to show whether there are surplus net assets after accruing for all liabilities each month.

“We are seeing many instances where companies don’t have proper processes in place to protect themselves if the trading dashboard starts flashing orange or red.”

Tate concluded: “Concerned director owners should seek professional advice at the earliest opportunity when, first, they see a sustained drop in profitability, and, secondly, their balance sheet capital reserves are heading towards zero.

“If caught early enough, the unlawful dividend trap can be averted and the chances to turnaround or restructure the business are improved.”