What is a dividend?
The term ‘dividend’ is not defined in the Companies Act 2006 (“the Act”); instead the Act talks about distribution (s.829 CA 2006) which is defined very broadly. However, dividend as a term does indeed feature in the Act in s.548, and in s.669 as also in the Model Articles in Art 30
Distribution is defined to mean distribution of a company’s assets to its members, whether in cash or otherwise, subject to statutory exceptions. In determining whether a particular transaction is a distribution the courts generally adopt a substance-over-form approach, looking at the commercial reality of the transaction. The following are not distributions:
- The issue of properly paid-up bonus shares.
- The redemption or purchase of the company’s own shares out of capital or profits (subject to separate strict rules).
- A reduction of share capital confirmed by the court or by a solvency statement.
- Distribution of assets made during a formal company winding up.
The underlying principle behind the law surrounding distribution is ‘capital maintenance’: that is, protecting creditors by ensuring a company preserves its share capital. Originating in the landmark case of Trevor v Whitworth (1887), it establishes that a company cannot return contributed capital to its shareholders surreptitiously or at will. Under the Act, this doctrine dictates that dividends can only be paid out of distributable profits, and any unauthorised reduction of capital is void.
Unlawful distribution
A company cannot return capital to its shareholders except in ways strictly permitted by law. This fundamental rule protects corporate creditors by ensuring that the fund available to pay a company’s debts is not improperly eroded. When a company returns value to its shareholders outside these strict boundaries, it makes an unlawful distribution. As noted above, the law governing unlawful distributions is founded on the capital maintenance doctrine, which protects creditors by ensuring that a company’s capital is not returned to shareholders except in accordance with statutory procedures. Part 23 of the Act codifies the principle that dividends and other distributions may only be paid from distributable profits.
Distributable profits
S.830 sets out the core restriction for all companies. A company may only make a distribution out of “profits available for the purpose”. These available profits are legally termed “distributable profits.” They are defined as the company’s accumulated, realised profits (not previously utilised by distribution or capitalisation) less its accumulated, realised losses (not previously written off in a reduction or reorganisation of capital). Crucially, a company cannot distribute unrealised profits, such as a paper profit resulting from the upward revaluation of an asset.
Additional restrictions for public companies
Public limited companies (PLCs) face a stricter net asset test under s.831. A PLC may only make a distribution if the amount of its net assets is not less than the aggregate of its called-up share capital and undistributable reserves. Furthermore, the distribution must not reduce the amount of those net assets to less than that aggregate.
Relevant Accounts
Whether a company has sufficient distributable profits is determined by reference to “relevant accounts” (s.836). Generally, these are the company’s last annual accounts (s.837). However, if these accounts do not show enough profits, the company must prepare “interim accounts” (s.838) to justify the distribution. For a new company, “initial accounts” (s.839) must be prepared. Failure to use proper, GAAP compliant accounts to justify a dividend makes the distribution unlawful, even if the company actually had the money in the bank. These provisions ensure that distributions are based on accurate financial information rather than directors’ estimates.
Consequences and liabilities
The company law provisions on unlawful distributions strike a balance between allowing companies to distribute genuine profits and protecting creditors through the capital maintenance doctrine. While the statutory rules provide financial certainty, litigation has demonstrated that courts will focus on the substance rather than the form of transactions to prevent disguised returns of capital. The combined effect of the company law provisions and judicial decisions ensures that directors cannot evade the restrictions through creative corporate structures and transactions.
Aveling Barford Ltd v Perion Ltd [1989] BCLC 626 – disguised distribution dressed up as real distribution
These two companies were under the common control of the same individual. Aveling Barford Ltd sold a property worth £1,150,000 to Perion Ltd for £350,000 and later went into liquidation. The liquidator successfully sued to have Perion be declared a constructive trustee of the proceeds realised by Perion on the resale of the property. The court held that although the transaction was a genuine sale and not a sham, the deliberate sale at a gross undervalue to a company under common control was, in substance, a “dressed-up” or disguised distribution to the shareholder. Because Aveling had no distributable profits, the transaction constituted an unlawful return of capital and was ultra vires and incapable of ratification. Perion was therefore accountable as a constructive trustee of the property and its proceeds. The case established that whether or not a transaction amounts to a distribution depends on its substance rather than its form, so a transfer need not be labelled a dividend to constitute an unlawful distribution.
Bairstow v Queens Moat Houses plc [2001] EWCA Civ 712 – importance of ‘relevant accounts’.
The Court of Appeal confirmed that dividends declared otherwise than by reference to properly prepared relevant accounts showing sufficient distributable profits are unlawful, even where the directors honestly relied on inaccurate accounts. Directors who authorise such payments may be personally liable for breach of duty. This case emphasised the mandatory nature of the statutory accounting requirements. Dividends in this case were declared on the basis of accounts that overstated the company’s distributable profits. The Court of Appeal held that the statutory requirement to determine distributable profits by reference to properly prepared relevant accounts was not met. The directors could not rely on evidence of actual profits outside the statutory accounting framework, because the legislation requires distributable profits to be established by reference to properly prepared relevant accounts. In summary, the case emphasises that the statutory rules on capital maintenance require strict adherence to the requirement that distributable profits be established by ‘relevant accounts’ (now s.836 CA 2006), and directors cannot justify an unlawful dividend by relying on evidence of actual profits outside that statutory accounting framework.
It’s A Wrap (UK) Ltd v Gula [2006] EWCA Civ 544 – emphasis on repayment by the shareholder
The liquidator of this company in liquidation, sought recovery of dividends totalling £28,000 paid to the respondents, Mr and Mrs Gula, who were directors and shareholders. The company made trading losses of £17,641 and £36,591 in 2001 and 2002 respectively, yet dividends of £14,000 each were paid to the respondents in both years. The payments were deliberately classified as dividends for tax efficiency purposes. The respondents admitted knowledge that the company had made losses, but claimed they were unaware that declaring dividends without profits contravened the Companies Act.
The court held that shareholders cannot escape liability for repaying unlawful distributions by claiming ignorance of company law. The decision reflects the policy of the capital maintenance doctrine, which protects creditors by requiring unlawful distributions to be repaid. A shareholder who knows that the company has made losses and nevertheless receives payments characterised as dividends cannot avoid liability by claiming ignorance of the company law prohibitions.
The decision illustrates the operation of what is now s.847 CA 2006.
Progress Property Co Ltd v Moorgarth Group Ltd [2010] UKSC 55 – emphasis on commercial substance of the transaction.
In this case the Supreme Court emphasised that transactions should be assessed objectively. Quoting from the Aveling Barford case the court noted:
“Whether or not the transaction is a distribution to shareholders does not depend exclusively on what the parties choose to call it. The court looks at the substance rather than the outward appearance.”
In terms of facts, this Progress Property Co Ltd sold its entire shareholding in its subsidiary to Moorgarth Group Ltd, another company under the common control of the same individual, which the liquidator alleged had been sold at an undervalue. The court clarified that when determining whether an undervalue transaction is an unlawful distribution, the court must examine the objective commercial substance of the transaction rather than merely its form. A genuine, good-faith error in valuing an asset during a commercial transaction does not automatically render the sale an unlawful distribution.
BTI 2014 LLC v Sequana SA [2022] UKSC 25 – fiduciary duties and personal liability of the directors
In this landmark decision, the Supreme Court examined the common law duty of directors to consider the interests of creditors and its relationship with lawful distributions under Part 23 of the Act. The Court confirmed that a dividend may comply fully with the company law provisions on distributable profits yet it could still be a breach of directors’ fiduciary duties.
The creditor duty is engaged where directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that insolvency or insolvent liquidation is probable. At that stage, directors must give greater weight to the interests of creditors when making decisions affecting the company’s assets.
Paying a dividend in that context may therefore constitute a breach of duty and give rise to personal liability for directors, even though the distribution is technically lawful under the statutory capital maintenance rules.
Add2 Research & Development Ltd v dSPACE Ltd [2021] EWHC 1513 (Pat) – once again commercial substance of the transaction in focus.
The High Court in this case considered whether an intra-group transfer of patent rights amounted to an unlawful “disguised distribution”. The claimant, Add2 Research & Development Ltd, had received patents from Add2 Limited for no consideration as part of an internal restructuring within a group of companies under common control. After Add2 Limited later went into liquidation, dSPACE argued that the transfer was not a genuine commercial reorganisation but in substance a transfer of value to shareholders, and therefore an unlawful return of capital contrary to the capital maintenance rules.
The court rejected that argument, holding that the transaction did not amount to a disguised distribution. Applying the principles in Aveling Barford Ltd v Perion Ltd (1989) and, in particular, Progress Property Co Ltd v Moorgarth Group Ltd [2010] UKSC 55, the court emphasised that not every transaction at undervalue constitutes a distribution; there must be a real extraction of value for the benefit of shareholders in substance. Here, the transfer was properly characterised as an intra-group restructuring rather than shareholder value stripping, and there was insufficient evidence to justify re-characterisation. The decision therefore confirms the relatively narrow scope of the disguised distribution doctrine, especially in the context of bona fide corporate reorganisations.
The law on unlawful distributions, therefore, centres on the principle that shareholders should receive payments only from distributable realised profits. Whilst the company law prohibitions establish the statutory framework, these cases demonstrate the courts’ willingness to enforce the capital maintenance principle. Together, these authorities protect creditors, promote sound corporate governance, and preserve the integrity of company capital. When a distribution is found to be unlawful, liability falls on both the recipients and the directors who authorised it. Where a distribution is unlawful:
- the shareholder may be required to repay it under s.847 if aware of the illegality;
- directors may be personally liable for breach of statutory and fiduciary duties;
- the company or a liquidator may bring proceedings to recover the amount distributed; and
- the transaction may be set aside or treated as a breach of the capital maintenance rules.
The shareholder’s liability
Under s.847 of the Act, if a shareholder knows, or has reasonable grounds for believing, that a distribution (or part of it) is unlawful at the time it is made, they are liable to repay it to the company. In the case of private companies with owner-managers, this knowledge is almost always imputed to the shareholder. Innocent recipients who receive the distribution without such knowledge are generally protected.
Director(s)’ liability
Directors who authorise an unlawful distribution are often in breach of their statutory duties under the Act, particularly s.172 (duty to promote the success of the company) and s.174 (duty to exercise reasonable care, skill, and diligence). Directors can be held personally liable to misfeasance claims to reimburse the company for the full amount of the unlawful distribution. This liability is joint and several, meaning an individual director can be pursued for the entire loss. A director can only escape liability if they can prove they relied on properly prepared accounts and made an innocent, reasonable mistake. Authorising an unlawful distribution may constitute a breach of these duties and expose directors to personal liability.
Now the tax part
There is no reported appellate tax authority directly holding that an unlawful distribution constitutes a loan to a participator for the purposes of s.455 CTA 2010. Rather, HMRC’s published view (CTM15205) is that an unlawful dividend is held on constructive trust where the shareholder knew or ought to have known of the unlawfulness. In those circumstances, the company is treated as having made a loan to the participator, giving rise to a s.455 charge. This analysis is derived from the company law principles laid down certain past cases: for example, Precision Dippings Ltd v Precision Dippings Marketing Ltd [1986] 1 Ch 447 established the principle that the recipient shareholder holds those funds as a constructive trustee and must repay them to the company. Of course the shareholder’s liability to pay it back to the company is now codified in s.847 of the Act.
HMRC reiterated this position in its 2026 consultation on reforming the distributions framework:
” If the company in question is close .. an obligation to repay an unlawful dividend will result in a charge to tax on the company under s.455 CTA 2010 on the basis that this is a debt incurred by a participator in the company from which the funds or assets were extracted..” Also, if circumstances allow, HMRC may also determine that “dividends” paid regularly were in place of a salary to evade tax/NICs reclassifying the distributions as employment income, demanding back-dated PAYE income tax and National Insurance Contributions.
