Can dividends ever be paid from loss-making company?

Dividends are typically the most tax-efficient way for company owners to receive income. However, dividends can only be paid from profits. Is there any way for a loss-making company to pay dividends?

Income or profit extraction

For company owner-managers, the common tax planning strategy is to take a modest salary and the remainder of their income as dividends (also known as distributions). This strategy is generally effective, but it isn’t always feasible.

When a dividend can’t be paid

Under company law, dividends and other distributions to shareholders can only be paid when the company has reserves, meaning accumulated profits. If a company experiences a period of losses, these losses will reduce the reserves, potentially limiting or entirely preventing the payment of dividends. In such cases, if cash income is needed from the company, the only alternative is to take a salary, which incurs significant additional tax and National Insurance (NI) costs.

Example part 1

Adam’s sole income source is his company. Typically, he draws a salary equal to the tax-free allowance (£12,570 for 2024/25) and an additional £50,000 in dividends. However, after a few poor trading years, his company lacks the reserves to pay a dividend. Consequently, he takes an additional £50,000 as salary instead. After tax and NI contributions, this results in a net pay of £33,770. If he had been able to take the £50,000 as a dividend, the net amount after tax (with no NI on dividends) would have been £42,550. Thus, taking a salary leaves him nearly £9,000 worse off.

Tax-efficient alternative

Instead of taking all income as cash salary, Adam’s company, AA Ltd, might be able to cover expenses for services or goods that Adam would typically pay personally. Such expenses would be treated as taxable benefits in kind, potentially saving Adam NI contributions of up to 8% on the value of the bills paid by the company. However, this approach has limited scope since Adam will still need cash for obligations like his mortgage and other personal debts.

Tip.

Company share capital can be converted into reserves, which can then be paid as dividends.

Example part 2

Adam founded AA Ltd with an investment of £120,000 in exchange for 100 ordinary £1 shares. For accounting purposes, £100 is recorded as share capital, and the remaining £119,900 is recorded as a share premium (the amount paid in excess of the share’s nominal value). Due to trading losses, AA’s Ltd latest accounts show negative reserves of £25,000. However, company law permits the repayment of all or part of the share premium, provided the company remains solvent. The repaid amount can be credited to the profit and loss account. AA Ltd repays £75,000 of the share premium, which when credited to its profit and loss account, changes the negative £25,000 reserves to a positive £50,000, enabling AA Ltd to pay Adam a dividend.

A company can repay share capital and share premiums, which can then be credited to its profit and loss account. This can result in positive reserves on the balance sheet, allowing the company to pay dividends from these reserves.

This Tax Memo was Written by © Indicator – FL Memo Ltd