Contractors can declare a dividend before they have been paid for work completed, or even before they have invoiced the client for the work. This can be particularly important when seeking to declare dividends for tax reasons but if there is no cash to pay them.
“The profit for the company is being generated as the work is completed,” explains James Abbott, founder and head of tax at contractor accountant Abbott Moore.
“So as long as the contractor is satisfied that it is true profit that is genuinely ‘invoicable’, then they are entitled to take work completed but un-invoiced and unpaid into account when determining whether there is sufficient profit to take a dividend.”
However, Abbott warns that there are pitfalls, and that contractors should talk through their options with their accountant before taking such a course of action.
Reasons for declaring a dividend when there is no cash to pay it
Abbott’s experience is that contractors maintain business records based on money coming in and money going out, and often think that if they don’t have the cash in the business bank account, then they can’t pay a dividend
“This is actually a good mantra to adopt, but there may be circumstances when dividend timing is crucial,” he says. “A typical example is when a contractor is having a slow year, and they are trying to use as much of their basic rate band as possible, but are finding it difficult because, in cash terms, the profit is not there.”
So as long as the contractor is satisfied that it is true profit that is genuinely 'invoicable', then they are entitled to take work completed but un-invoiced and unpaid into account when determining whether there is sufficient profit to take a dividend
James Abbott, Abbott Moore
That’s when it might be a good idea to complete a more accurate calculation of their financial position to determine whether any dividends are available.
If I don’t have the cash, how can I pay a dividend?
As long as the contractor is up-to-date with their bookkeeping, including expenses, money owed to suppliers and the taxman, then they should never be in a position when they are declaring a profit that does not exist.
The ability to declare a dividend based on completed work hinges on the point when the contractor and their accountant are satisfied that there is a profit to draw on. So, for example, when they prepare the figures for the year-end accounts, contractors typically account for money coming in and going out.
“What their contractor accountant then does at year end is bring in the work completed and invoiced but unpaid, and any work completed before year end but not invoiced,” continues Abbott. “If there is a profit showing then a dividend can be declared.
Director’s loan account and board minutes
“That’s all well and good of course, but there might not be a penny in the bank to pay the dividend. In this case, the payment is credited to the director’s loan account for the contractor to drawn down as they wish.”
Abbott stresses the importance of board minutes and dividend vouchers when going through this process: “This is an occasion to make sure the paperwork is signed, as often there is no other evidence that the dividend has been declared and HMRC could classify any future payment as salary, or an illegal dividend.
“I ask my clients to send me copies, or email me scans, of the signed board minutes and dividend vouchers. That ensures that there is independent verification of the timing of the transaction. Contractors should never backdate this paperwork, as that is fraud.”
Calculating the dividend with unpaid invoices and un-invoiced work
“Contractors do need to take into account the bad news as well if calculating in money owed and not paid for, which means accounting for liabilities,” notes Abbott. These include:
- Unpaid expenses to the director
- Unpaid supplier costs, including accountancy fees not invoiced and paid for the period
- Outstanding corporation tax and VAT liabilities (and potentially Pay As You Earn (PAYE) income tax and National Insurance Contributions (NICs)
“When completing these calculations for my clients, I always allow a margin of error, because there are usually items not accounted for. It is only possible to make a reasonable estimate of the profits, so knock off a bit to allow for the calculations being wrong,” he adds.
As a director, the contractor also has an obligation to ensure that the unpaid un-invoiced funds are ‘cleared’ and that there is no question as to whether they will be paid.
Abbott explains: “If, for example, the contractor has raised two invoices, neither has been paid, the client is disputing the work and the contractor has also heard the client is in financial difficulties, then they need to think very carefully before declaring a dividend on that amount.”
“Best practice is still to deal in cash and only pay dividends when all the money has been collected and the contractor knows their exact financial position. And if a contractor thinks they may require a dividend based on calculated profits, they really need to understand their situation and work out the profits and potential dividend with their accountant.”