Dividend advance. How to proceed correctly?

A common question is whether it is possible to provide owners with a distribution from profits before the annual financial statements are approved. Yes, this is exactly what a dividend advance is designed for. It allows a company to pay owners in advance from its expected profit, but its use is subject to strict rules. This is the focus of today’s blog post. 

What is a dividend advance?

The essence of a dividend advance is that the company makes a payment to its owners based on the results of the current business year before it is closed. It is important to clarify that this payment is not the same as the final annual dividend. A dividend can only be paid after the annual financial statements have been approved, and a decision can only be made at that time. In contrast, a dividend advance may be approved at any time during the year and paid from retained earnings and the current year’s expected profit.

Legal framework

The most important conditions for paying a dividend advance are the following:

• The company must prepare a balance sheet showing that the payment does not jeopardize its solvency. This is called an interim balance sheet, and the same rules apply to it as to annual financial statements. If a statutory audit is required, the interim balance sheet must also be audited.
• The amount of the payment must not exceed the available retained earnings and the expected profit.
• A decision by the owners is required before payment, documented in the form of a shareholders’ meeting resolution or a founding decision.

Payment and accounting treatment

In practice, the payment process is as follows:

1. The owners or the managing director decide on the amount of the advance.
2. The payment must be recorded in the accounting records as an advance, clearly separated from the final dividend.
3. At the time of payment, the company must review its tax declaration and payment obligations, submit the required tax returns, and pay the related taxes. 

The advance must later be settled against the final dividend and removed from the accounts.

Taxation rules

Taxation of a dividend advance becomes due at the time of payment. In the case of an individual owner, personal income tax at a rate of 15% must be withheld.

Under the rules governing social contribution tax, no such tax is payable on a dividend advance. Social contribution tax is only due on the final dividend. Therefore, no action is required regarding this tax at the time the advance is calculated and paid. 

Common mistakes and risks

The most frequent issues related to dividend advances include:

• Liquidity problems: meaning payment of an amount for which the company does not have sufficient financial coverage.
• Unlawful payments: when no interim balance sheet is prepared or when the balance sheet does not allow the payment. In such cases, owners may become personally liable.
• Accounting deficiencies: where the advance is incorrectly recorded in the accounts or financial statements, potentially resulting in tax consequences and penalties.
• Failure to meet tax obligations: including omission or incorrect handling of tax liabilities related to the dividend advance, which may lead to tax shortfalls and default penalties.
• Settlement issues at a later stage: as mentioned above, the dividend advance must be converted into a dividend when the annual financial statements are approved, related taxes must be settled, including possible social contribution tax at that stage, and the legal title of the payment must be properly reflected in the submitted tax returns.

Repayment obligation: many forget that a dividend advance does not represent a final acquisition of assets for the owner. Until it is converted into a dividend, the owner may be required to repay it if the company’s results or equity later do not support dividend payment.