Court clarifies when an interim dividend becomes a debt

17 October 2024

The Upper Tribunal has held that, unless a company and its shareholders agree otherwise, where a company decides to pay an interim dividend to its shareholders but in fact pays only some of them, a debt automatically arises in favour of the shareholders it has not yet paid.

There are two ways for a UK company to pay a dividend: following a declaration by the shareholders (a final dividend) or following a decision by the directors (an interim dividend).
Different shareholders should be able to agree to be paid an interim dividend on different dates. This could be useful for strategically timing payments, including for tax purposes.
However, the directors can (and, in some scenarios, may be obliged to) revoke an interim dividend at any time before it is paid, potentially leaving a shareholder at risk of non-payment.

What happened?

HMRC v Gould [2024] UKUT 00285 (TCC) concerned a company with (for all practical intents and purposes) two shareholders (who were also brothers). One of those shareholders was resident in the UK. The other had settled in Jamaica, having previously resided for some time in the United States.

In 2015, the company ended up holding cash surplus to its needs. The directors therefore decided to return the cash to the company’s shareholders by paying a dividend.

The rate of UK tax on company dividends was due to increase in the 2016/17 tax year. As a result, it was more tax-efficient for the UK-resident shareholder to be paid his dividend in the 2015/16 tax year.

The Jamaica-resident shareholder would not normally be liable to pay UK tax. However, due to family circumstances, he had spent more time than usual in the UK during the 2015/16 tax year, creating some doubt over whether he had become tax-resident in the UK. In addition, he had been experiencing difficulties opening a bank account in Jamaica. As a result, it was safer and more tax-efficient for him to be paid his dividend in the 2016/17 tax year.

For UK tax purposes, income tax is charged on the amount or value of dividends paid in the tax year. Dividends are treated as “paid” when they become due and payable (i.e. the point at which the obligation to pay the dividend becomes a present debt owed to the shareholder). In some circumstances, this can be earlier than the date the cash is paid to the shareholder. The UK tax year runs from 6 April to 5 April annually.

Company dividends can be paid in one of two ways (see box “The different types of dividend” below).

If the company’s shareholders were to declare a dividend, the debt (and so payment for UK tax purposes) would have arisen in the 2015/16 tax year, to the disadvantage of the Jamaica-resident shareholder.

The directors therefore decided to pay an interim dividend and defer payment of the Jamaica-resident shareholder’s entitlement to the 2016/17 tax year. Because an interim dividend does not generally become a debt until it is actually paid, the idea was that, for tax purposes, the UK-resident shareholder would be treated as having been paid his dividend in 2015/16 and the Jamaica-resident shareholder in 2016/17.

The directors therefore approved the interim dividend on 31 March 2016, paid the UK-resident shareholder his dividend on 5 April 2016 (the last day of the 2015/16 tax year) and paid the Jamaica-resident shareholder his dividend on 16 December 2016 (in the 2016/17 tax year).

English law essentially recognises two ways in which a company can pay a dividend:

The directors can recommend a dividend to the company’s shareholders, who then resolve (by passing an ordinary resolution) to declare the dividend. This kind of dividend is often called a final dividend, as it is traditionally paid at the end of a company’s financial year once its profits have been ascertained. However, a company’s shareholders can declare a dividend at any point. If they do so before the company’s financial year-end, the dividend may well be termed a special dividend. We use the term “shareholder-declared dividend”.
The directors can decide to pay a dividend by passing a resolution among themselves (normally in a board meeting). This kind of dividend is known as an interim dividend, as it is normally paid during the course of a company’s financial year. Directors can pay interim dividends only if the company’s constitution allows them to. Model company constitutions (such as the Model Articles and its predecessor, Table A) permit interim dividends.

A key distinction between these two types of dividend is the point at which the dividend becomes a debt. Once a dividend has become a debt, the directors or company cannot revoke it and the shareholder becomes entitled to enforce payment (e.g. by bringing legal proceedings).

A shareholder-declared dividend becomes a debt at the time specified for payment in the shareholder resolution declaring it. If the resolution doesn’t specify a time for payment, it becomes due immediately. In either case, a shareholder gains a right of enforcement from declaration.

By contrast, an interim dividend does not become a debt until it is actually paid to some or all of the shareholders (a point which this case clarifies). This is a curious legal concept, as clearly the debt is both created and discharged at the same point in time. However, the purpose of this is to allow the directors to revoke the interim dividend at any point before payment. This might be necessary if (for example) the company’s financial position deteriorates and the company needs the cash to satisfy payments to its creditors.

The flexibility inherent in an interim dividend might make it seem like a more attractive choice generally, particularly for private companies that do not need to adhere to typical traded company dividend timetables. However, there can be good reasons to opt for a shareholder-declared dividend.

A shareholder-declared dividend creates a debt which the shareholder can then assign on. This may be useful when looking to distribute profits up a chain of companies to the ultimate holding company and beyond.
Declaring a dividend by shareholder resolution can be useful when remedying unlawful dividends or procedural defects in share buy-backs.
By declaring a dividend, shareholders can fix a firm and binding date for payment. What is more, the dividend cannot be revoked and so is not susceptible to a change of mind by the directors or a subsequent worsening in the company’s financial state.

The initial decision

HMRC assessed tax on the Jamaica-resident shareholder’s dividend in respect of the 2015/16 tax year. The shareholder appealed to the First-tier Tribunal against HMRC’s decision.

HMRC claimed that, although an interim dividend does not normally become a debt until it is actually paid, in this case, the Jamaica-resident shareholder’s dividend had become a debt when the UK-resident shareholder was paid his dividend.

This (it claimed) was because the company’s constitution and English common law both required the company to pay dividends equally and proportionately across shares of the same class. In this case, both shareholders held shares of the same class and so should have been paid at the same time.

As a result (HMRC argued), the dividend had become due and payable on 5 April 2016 and the Jamaica-resident shareholder had become entitled to enforce payment or to seek some other remedy entitling him to compensation, such as a petition in unfair prejudice. He was therefore treated as having been paid his dividend during the 2015/16 tax year and was liable to pay tax on it.

The Tribunal rejected this argument.

It agreed that the company was required to treat both shareholders equally. It also agreed that a failure to pay an interim dividend to all shareholders at the same time could give rise to legal remedies for any unpaid shareholders, such as a petition in unfair prejudice.

However, it could find nothing in the company’s constitution (which had adopted Table A) suggesting that a debt arose if an interim dividend was paid to different shareholders at different times.

As a result, the Jamaica-resident shareholder was treated as having been paid his dividend, for tax purposes, in the 2016/17 tax year, as intended.

HMRC appealed.

What did the Upper Tribunal say?

In contrast to the First-tier Tribunal’s decision, the Upper Tribunal agreed in principle that, when a company pays an interim dividend to one shareholder but not another shareholder of the same class, a debt arises in favour of the other shareholder.

This is because (as HMRC had argued) it is a fundamental principle of company law that all shareholders of the same class are to be treated equally. This includes in relation to the timing of any dividend payments.

This was also the effect of regulation 104 of Table A, which formed part of the company’s constitution. Regulation 104 states:

“Except as otherwise provided by the rights attached to shares, all dividends shall be declared and paid according to the amounts paid up on the shares on which the dividend is paid. All dividends shall be apportioned and paid proportionately to the amounts paid up on the shares during any portion or portions of the period in respect of which the dividend is paid; but, if any share is issued on terms providing that it shall rank for dividend as from a particular date, that share shall rank for dividend accordingly.”

Because regulation 104 refers to dividends being “declared and paid”, and interim dividends are never “declared”, the First-tier Tribunal had interpreted it as applying only to shareholder-declared dividends.

The Upper Tribunal disagreed, finding that there was no reason to read regulation 104 as applying to certain kinds of dividend. In particular, it found that the words “[a]ll dividends shall be apportioned and paid proportionately to the amounts paid up on the shares” were capable of applying to interim dividends as well as shareholder-declared dividends.

However, it also held that the company and its shareholders were free to vary the default position so as to pay the same interim dividend to different shareholders at different times. In that case, no debt would arise in favour of an individual shareholder until the dividend was payable to that shareholder.

That, the Tribunal held, was what had happened in this case. The company and its shareholders had all agreed that the Jamaica-resident shareholder would be paid at a later date. In law, they had amended the company’s constitution under the Duomatic principle to allow it to pay the same interim dividend on different dates to different shareholders.

As a result, no debt had arisen in favour of the Jamaica-resident shareholder at the point the company paid the dividend to the UK-resident shareholder.

What does this mean for me?

The Upper Tribunal’s decision is an interesting development of the position on interim dividends.

It remains the case, as it was before this case, that an interim dividend does not become a debt until it is paid to at least one of the relevant shareholders.

For a company that has adopted Table A, the effect of regulation 104 is that the first payment of an interim dividend to a shareholder will crystallise a debt in favour of all shareholders who are entitled to the dividend (and will be treated as the payment of the dividend to all shareholders for tax purposes).

A company is free to modify or disapply regulation 104. However, if this has not already been done in the company’s articles, the shareholders will amend them to achieve this. Alternatively, individual shareholders may be able to waive their right to enforce payment of the interim dividend until a later date and achieve the same result.

Shareholders who wish to do this should take care to waive their right to enforce payment before the debt crystallises (i.e. before payment is made to any other shareholder).

Table A has now been replaced by the Model Articles, and many companies have updated their constitutions to incorporate them in place of Table A. The Model Articles for private companies contain no equivalent of regulation 104. However, under the principle of equal treatment of shareholders, the same position will apply. (Article 71 of the Model Articles for public companies is similar to regulation 104, but, in our experience, it is uncommon for public companies to adopt the Model Articles.)

The decision does not change the fact that interim dividends can provide useful flexibility for companies. In particular, they can enable directors (and any willing shareholders) to structure dividend payments according to a timetable that is convenient (whether for the company or its shareholders), including by arranging them in a tax-efficient way.

In particular, the case highlights the utility of interim dividends when considering changes to tax residency of individual shareholders and anticipating future changes to tax rates. It also provides a useful example of how a company can accommodate the different individual tax profiles of shareholders.

A shareholder whose dividend is deferred in this way takes a risk: if the company’s financial position gets worse, the directors may be obliged (in accordance with their duties to the company) to cancel the dividend. In that scenario, the shareholder will not receive the dividend. Shareholders will need to weigh this risk up on a case-by-case basis.

And, above all, it is important to take legal and tax advice when structuring dividends in this way to ensure they achieve the desired treatment.

Access the Upper Tribunal’s decision on when an interim dividend will become an enforceable debt (judgment in PDF format)

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