You cannot pay dividends if your agency has made a loss in the current year. This is a legal requirement under the Companies Act 2006, not just a tax point. Dividends can only be paid from "distributable profits", essentially, the accumulated retained profits your agency has built up over time, not the current year's performance alone.
This catches a lot of agency founders off guard. You might have a strong retained reserve from previous years but hit a rough patch this year. Or you might have assumed that because you have cash in the bank, you can pay a dividend. Cash and profit are not the same thing. And HMRC, along with company law, cares about the latter.
Let me walk through exactly how this works, what happens if you get it wrong, and what you can do instead.
What the Law Says About Distributable Profits
Section 830 of the Companies Act 2006 is clear. A dividend can only be paid out of "profits available for the purpose." Those are your accumulated, realised profits minus your accumulated, realised losses. This is calculated over the life of the company, not just the current financial year.
So here is the scenario that causes confusion:
- Your agency made £80,000 profit last year. You paid yourself a dividend of £60,000.
- This year, you have a loss of £20,000. You have cash in the bank from last year's retained profits.
- Can you pay a dividend this year? Yes, but only if you have sufficient retained profits remaining from previous years.
The loss in the current year does not automatically prevent a dividend. What matters is whether your total retained earnings (the profit and loss reserve on your balance sheet) are still positive after accounting for the loss.
If your retained earnings were £80,000, you paid out £60,000, and this year you lost £20,000, your retained earnings are now zero. You cannot pay a dividend until you generate more profit.
The Two Key Tests for a Lawful Dividend
1. The Profit Test
Your agency must have distributable profits. These are calculated using your annual accounts, management accounts, or interim accounts (depending on when you pay the dividend). You cannot rely on cash flow alone. A profitable-looking P&L does not automatically mean you have distributable profits either, you need to check the retained earnings on your balance sheet.
2. The Liquidity Test
Even if you have distributable profits on paper, you need to consider whether paying the dividend would leave your agency unable to pay its debts as they fall due. This is the wrongful trading risk. If you pay a dividend and your agency becomes insolvent within 12 months, the dividend could be clawed back and you could face personal liability.
Working exclusively with agency founders, we see founders focus entirely on the profit test and forget the liquidity test. Both matter.
What Happens If You Pay a Dividend From a Loss
If you pay a dividend when your agency does not have sufficient distributable profits, that dividend is unlawful. The consequences are serious:
- Directors' personal liability: You can be required to repay the full amount of the unlawful dividend to the company. If multiple directors approved it, you are jointly and severally liable.
- HMRC penalties: If you have already accounted for the dividend on your personal tax return, HMRC will still treat it as income. But the company cannot claim the dividend as a deduction. You end up paying tax on money you might have to repay.
- Insolvency risk: If your agency later enters insolvency, the liquidator will look at dividends paid in the 2 years prior. Unlawful dividends are recoverable.
I have seen a 15-person digital agency in Shoreditch get caught by this. They had a loss-making year but paid themselves a £40,000 dividend because they had cash from a previous retainer contract. The retained earnings were already exhausted from earlier dividends. The director had to repay the full amount personally. It was an expensive mistake.
What to Do Instead of Paying a Dividend From a Loss
If your agency has made a loss and you do not have sufficient retained profits, you have options. None of them involve paying a dividend.
Option 1: Take a Salary Instead
You can pay yourself a salary even in a loss-making year. Salary is a deductible expense for the company, so it reduces the loss further. But it also triggers PAYE and National Insurance. For a loss-making agency, the tax efficiency argument for salary over dividends is weaker. Still, if you need personal income, it is lawful.
If you are already taking the standard £12,570 salary (up to the NI primary threshold), you could increase it. Just be aware of the employer NI cost at 15% and your own income tax at your marginal rate.
Option 2: Use a Directors' Loan
You can borrow money from your agency as a directors' loan. This is not a dividend. It is a debt you owe the company. You must repay it within 9 months of your year-end, or the company faces a Section 455 tax charge at 35.75% of the outstanding amount.
Directors' loans over £10,000 must be reported on your P11D and are a benefit in kind. They also affect your personal tax position. This is a short-term solution, not a long-term income strategy.
Option 3: Defer the Dividend
Wait until your agency returns to profitability. If you have a strong pipeline, you might be profitable again within 6 months. At that point, you can pay a dividend from the new profits (assuming you have rebuilt your retained earnings).
This is the most common approach we recommend. It avoids all the legal and tax risks. It also forces you to manage your personal cash flow more carefully, which is often a good discipline.
Option 4: Restructure Your Shareholding
If your agency has multiple shareholders and some want income while others do not, you could consider a share buyback or a capital reduction. These are more complex and require legal advice. But they can release retained profits in a different way.
This is not a DIY option. Speak to your accountant and a corporate solicitor before pursuing it.
How to Check If You Can Pay a Dividend Right Now
Here is a simple process you can run through with your accountant:
- Open your most recent balance sheet. Look at the "Profit and Loss Reserve" (or "Retained Earnings") figure. This is your accumulated distributable profit.
- Subtract any dividends already declared in the current financial year (even if not yet paid).
- Add back any losses made so far this year (if your management accounts show a loss, it reduces the retained reserve).
- If the result is positive, you have distributable profits. If it is zero or negative, you do not.
For example: your balance sheet shows retained earnings of £45,000. You have already declared £30,000 of dividends this year. Your current year loss is £20,000. Available retained profits: £45,000 - £30,000 - £20,000 = -£5,000. You cannot pay a dividend.
If you use accounting software like Xero or QuickBooks, your accountant can run a "distributable profits check" from your trial balance. Do not rely on the cash balance in your bank account. It is irrelevant for this test.
What About Interim Dividends?
Interim dividends (paid during the year, before final accounts are prepared) are common for agency founders. You pay them based on interim management accounts. The same rule applies: you must have sufficient distributable profits at the time of declaration.
If you pay an interim dividend based on a forecast that does not materialise, and your year-end accounts show a loss that wipes out retained profits, that interim dividend becomes unlawful. You would need to reverse it or have the directors personally repay it.
This is why we recommend caution with large interim dividends in volatile years. If your agency's revenue is lumpy (project-based rather than retainer), wait until you have at least 6 months of confirmed profitability before declaring a significant dividend.
Can You Pay Dividends From a Loss Year If You Have a Holding Company?
If your agency sits under a holding company structure, the rules are slightly different. The holding company can receive dividends from its subsidiaries (if those subsidiaries have distributable profits). The holding company then has its own distributable profits from those dividends and can pay dividends to you as the ultimate shareholder.
But if the holding company itself has made a loss (because its costs exceed the dividends received), the same rule applies. It cannot pay a dividend from a loss. The structure does not bypass the legal requirement.
We work with several agency groups that use holding companies for tax planning and exit readiness. The dividend rules apply at every level.
What If You Have Already Paid an Unlawful Dividend?
If you realise you have paid a dividend from a loss year without sufficient retained profits, act quickly. The longer it sits, the harder it is to fix.
You have two options:
- Repay the dividend to the company. This reverses the transaction. You will need to adjust your personal tax return if you have already declared the dividend income.
- Formalise the repayment as a directors' loan. This converts the unlawful dividend into a debt. You then have 9 months from the year-end to repay it, or the company faces the Section 455 charge.
Neither option is ideal. Both are better than leaving an unlawful dividend on the books and hoping HMRC does not notice. HMRC reviews dividend payments as part of corporation tax compliance checks. If your retained earnings do not support the dividends shown in your accounts, they will ask questions.
When to Speak to Your Accountant
If any of the following apply, talk to your accountant before declaring your next dividend:
- Your agency has made a loss in the current year
- Your retained earnings are below £50,000
- You have paid more than one dividend in the last 12 months
- You are unsure what your retained earnings figure is
- Your agency uses a holding company structure
We handle this regularly for marketing agencies and digital agencies that experience the natural revenue fluctuations of project-based work. A quick retained earnings check takes 10 minutes and saves you from a potentially expensive mistake.
If your contractor mix has changed in the last 12 months, or your retainer book has shrunk, ask your accountant before year-end. Do not assume last year's dividend pattern is safe this year.
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