Contractors who do not justify dividend declaration decisions or complete the correct paperwork could have their dividends declared illegal by HM Revenue and Customs (HMRC), one website warns.

For freelancers who are confused as to what constitutes an illegal dividend, contractorcalculator has written a guide detailing what they are.

James Abbott of Baker Watkin's tax department told the site that illegal dividends can be declared when there are not enough profits to cover the divided when it is paid.

It can also be illegal, he warns, if a contractor does not take board meeting minutes of the decision or does not complete a dividend voucher for shareholders.

"If you've kept the records that prove the decision to declare a dividend subsequently deemed illegal was a reasonable judgement at the time, then HMRC would have difficulty in classifying this income as salary," Mr Abbott says.

This follows news that contractors using tax avoidance schemes may soon find their income subject to taxation due to new laws coming into play in April 2011.