What happens if I took dividends with no profits?

Company law only allows a dividend when the company has enough distributable profit to cover it, based on relevant accounts. If it doesn't, the dividend is unlawful, no matter how it was documented.

HMRC doesn't police company law directly, but it does police the tax consequences. If your dividend wasn't lawfully paid, HMRC will typically say it wasn't a dividend at all for tax purposes.

Instead, HMRC recharacterises the payment, most often as a director's loan, sometimes as employment income. Either route usually means more tax than the dividend rates you originally applied.

Part 23 Companies Act 2006 sets the framework for lawful distributions. Section 830 requires a company to have profits available for the purpose, meaning accumulated realised profits not previously distributed, less accumulated realised losses.

Section 836 requires the profits available to be justified by relevant accounts, usually the last annual accounts, prepared in line with the relevant financial reporting standard.

If accounts don't support the dividend, section 847 makes clear that a shareholder who receives a distribution knowing it was unlawful must repay it. This is a civil company law liability, separate from any tax charge.

For tax purposes, HMRC's own manuals confirm it will look at the substance of the payment. Where the paperwork calls it a dividend but the company had no profits, HMRC will normally tax it as a loan under section 455 CTA 2010, or as earnings if it looks like disguised remuneration.

If HMRC is questioning your dividends during an enquiry, they're usually checking whether interim accounts or management accounts actually supported the distributable reserves at the time you declared each dividend.

Many small companies declare dividends monthly without preparing accounts to justify them. This is common practice, but it's exactly the point HMRC will test if the company later shows a loss.

If a dividend is reclassified as a loan, the company may owe s455 tax under Corporation Tax Act 2010, and you as director may face a benefit-in-kind charge and Class 1A National Insurance if the loan is interest-free or below the official rate.

If HMRC treats it as earnings instead, PAYE and Class 1 National Insurance apply, often with interest and penalties on top because the tax should have been deducted at source.

The direct cost is the extra tax difference between dividend rates and loan or salary treatment, plus interest from when the tax should originally have been paid.

If HMRC considers the dividend was declared carelessly, without proper reserves being checked, a behaviour-based penalty under Schedule 24 Finance Act 2007 can follow on top of the tax and interest.

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Don't declare dividends purely by reference to bank balance. Distributable reserves are an accounting concept, not a cash balance, and the two can diverge significantly.

Don't skip management accounts before declaring interim dividends. A simple set of figures, even unaudited, is far better evidence than nothing.

Don't assume a loss discovered later automatically makes an earlier dividend unlawful. What matters is the position shown in the accounts you relied on at the time.

Don't wait until a loss appears to correct the position. If a dividend turns out to be unlawful, dealing with it promptly, including possible repayment, limits the tax and company law fallout.