Directors Remuneration – The Pitfalls
At the start of last year there were 5.5 million small businesses in the UK. This represents a staggering 99.2% of the total business population and a summary of the numbers is below:
- Small businesses (0 to 49 employees) → 5.5 million businesses
- Medium businesses (50 to 249 employees) → 35,600 businesses
- Large businesses (250 or more employees) → 7,700 businesses
Many of the SME’s are owner-managed, and it is common for directors to pay themselves a modest salary (usually equivalent to the personal tax allowance), and to receive the balance of their remuneration package by way of dividends.
This is often the most tax efficient way to manage directors’ remuneration, however, this can cause problems for directors, if the company subsequently experiences financial difficulty.
It is important for directors to be aware of the potential consequences of their remuneration structure, in the event the company becomes insolvent.
Rules relating to directors’ remuneration
Directors’ remuneration refers to how a director is compensated (or paid) by a company for their services, usually by salary (wages), and other benefits.
It is important to understand that a director is not necessarily an employee and where there is no express provision within the company’s articles, there is no automatic entitlement to receive a salary.
If a company has not implemented its own rules, the model articles of association will apply, as prescribed by the Companies Act 2006. For companies incorporated on or after 28 April 2013, directors are entitled to receive remuneration decided by the board of directors. There are other obligations to produce a remuneration report, and to provide the same information in the company’s accounts.
Directors’ drawings and dividends
Where a director is also a shareholder, the accounting treatment of dividends is commonly (although not necessarily correct) for the funds received by a director, in excess of the salary, to create an overdrawn loan account, which is then cleared by the declaration of an equivalent dividend declared at the company’s year-end.
This approach often causes problems when a company finds itself in financial difficulty. In these cases, many directors find that the company does not have distributable reserves and therefore a dividend equivalent to the amount drawn cannot be declared.
Ultimately, this results in the loan account remaining overdrawn and recent case law confirms that directors cannot simply re-characterise drawings at a later date.
What should directors’ do to protect their position?
It is essential to maintain adequate books and records, with particular reference to any key transactions between the company and the director. This will be particularly helpful where a company has entered into an insolvency process and the company’s transactions are subject to review.
Owner-managers should consider their position, at the outset, and periodically thereafter. It is worthwhile considering whether it would be appropriate to be paid a higher salary, or stick to the common approach of nominal salary and dividends. Personal tax advantages should be balanced with the risks highlighted above.
Planning ahead is also extremely important. Keeping close control of the company’s financial position can help you to deal with problems before they escalate. Not all problems can be anticipated and when a director becomes aware of problems which cannot be overcome, he or she, should seek immediate advice.
Help from Licenced Insolvency Practitioners
Keywood Group is a firm of Licenced Insolvency Practitioners with offices in Birmingham and London. Our Licenced Insolvency Practitioner is fully licenced and regulated by The Insolvency Practitioners Association.
We work extensively with owner-managed businesses and are pride ourselves on being fully transparent about directors’ remuneration, and director loans at the outset of any process. If a potential problem is obvious then we will notify you of this, and work with you to reach a sensible outcome.
If you want further information, please contact us for a no obligation chat.
