Can a Loss-Making Company Pay Dividends?

Can a Loss-Making Company Pay Dividends?

Dividends are a popular way for company shareholders to enjoy the profits of their investment. However, what happens when a company isn’t profitable? Can dividends still be paid? Let’s explore this topic step by step in simple terms, while introducing the key accounting principles behind it.

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How Can a Company Make a Loss?

A company is “making a loss” when its expenses are greater than its income. This means that the business is spending more money than it is earning over a certain period.

Here are some common reasons why a company might be making a loss:

1. Declining Revenue: A drop in sales or reduced demand for products or services can significantly impact income.
2. High Operating Costs: Expenses like salaries, rent, utilities, and raw materials may outweigh the revenue earned.
3. Large Investments: Spending heavily on growth, such as purchasing equipment or entering new markets, can lead to losses in the short term.
4. Debt and Interest Payments: Companies with high levels of debt may struggle to cover interest payments, which can eat into profits.
5. Unexpected Challenges: Events like economic downturns, supply chain disruptions, or new competitors entering the market can also lead to financial losses.

It’s important to note that a loss doesn’t necessarily mean the business is failing—it could be a temporary phase or part of a growth strategy.

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What Are Dividends, and How Are They Paid?

Dividends are payments made by a company to its shareholders as a way of sharing its profits. These payments are usually based on the company’s retained earnings, which is the accumulated profit left after paying taxes and any other obligations.

How Dividends Are Normally Paid

When a company earns a profit after paying taxes, the directors can decide how to use it:

• Some of the profit might be reinvested in the business.
• The remaining profit can be distributed to shareholders as dividends.

Shareholders can only withdraw dividends from the company’s retained earnings, which include:

• Current Year Profits: The profit made during the current financial year.
• Retained Earnings from Previous Years: Any leftover profit from earlier years that hasn’t been distributed.

For example:

• A company has £50,000 retained earnings from the previous year and makes a profit of £20,000 this year.
• Total available retained earnings = £50,000 + £20,000 = £70,000.
  
  This £70,000 is the maximum amount that can be distributed to shareholders as dividends.

Dividends must be distributed fairly among all shareholders based on the percentage of shares they own. For instance, if a shareholder owns 25% of the company’s shares, they are entitled to 25% of the total dividends declared.

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Can a Company Pay Dividends If It Is Making a Loss?

The short answer is: Yes, but only in specific circumstances.

Even if a company is making a loss in the current year, it can still pay dividends if its retained earnings remain positive after accounting for the loss. However, if the current loss is so large that the retained earnings become negative, the company cannot legally pay dividends.

Example:

• Retained Earnings from Previous Years = £100,000.
• Current Year Loss = £30,000.
• Total Retained Earnings = £100,000 – £30,000 = £70,000 (positive balance).

In this case, dividends can still be paid.

But if:

• Retained Earnings from Previous Years = £50,000.
• Current Year Loss = £60,000.
• Total Retained Earnings = £50,000 – £60,000 = -£10,000 (negative balance).

Here, dividends cannot be paid as there are no available retained earnings to distribute.

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Tax Implications of Dividends and Loss-Making Companies

It’s possible for shareholders to withdraw dividends during the year before the company’s accounts are finalised. However, if the company ends up with a loss or insufficient profit to cover these dividends, the excess amount is treated as a Director’s Loan Account (DLA).

What Is a Director’s Loan Account (DLA)?

A DLA occurs when a shareholder withdraws money from the company that isn’t covered by its dividends. If this loan isn’t repaid to the company within 9 months after the year-end, a Section 455 (S455) charge applies.

What Is the S455 Charge?

The S455 charge is a tax penalty applied to unpaid director loans. The tax rate (for the year 2024/25) is 33.75% of the outstanding loan balance.

How to Avoid the S455 Charge

To avoid this penalty:

• Any excess dividend must be repaid to the company within 9 months after the financial year ends.

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Conclusion

While it is possible for a loss-making company to pay dividends, this is only allowed if the retained earnings remain positive. However, careful consideration should be given to the company’s financial health before declaring dividends.

Withdrawing dividends beyond retained earnings can lead to tax penalties, such as the S455 charge, which can be avoided by repaying the excess within the required timeframe.

For companies navigating these complex scenarios, professional advice from a chartered accountant can ensure that both the business and shareholders stay compliant with tax regulations.

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If you have any questions about dividends, retained earnings, or tax compliance, our team at Naseems Accountants is here to help. Book a free consultation today!