Downside of opting for dividends over salary
How should directors of fast-growing companies be rewarded for their hard work? Jim James, Corporate Recovery partner at Ward Hadaway, has some cautionary words.
FEW would argue that directors of growing companies should be rewarded for their part in such success. But how should that happen?
Instead of paying themselves a salary, many directors of such companies opt to pay themselves dividends from the business.
There is some logic to this – those responsible for the company’s welfare get the rewards from its success and will receive payments in line with that success.
In addition, it means they are subject to lower rates of corporation tax, instead of income tax.
However, there are also a number of drawbacks, particularly in the context of the current economic climate.
Without wishing ill on anyone, such a practice could create serious personal financial problems for individuals whose businesses fail.
If a company fails, any insolvency practitioner (IP) appointed over it has a right to look for these dividends to be repaid, as part of maximising the monies available with which to pay creditors if they have been made when the company was not in a position to do so.
Dividends must be drawn from the company’s “distributable reserves”, which are comprised in the main of previous undistributed profits or profits identified by a set of accounts as already having been made.
If a company’s trading performance worsens, these reserves might eventually be used up, meaning any dividends drawn in such a way would not have been done so legitimately.
Some directors make the position worse by overdrawing on their loan account in anticipation of the payments being set off against future dividends.
As such, they would very much be in an IP’s sights should dividends have been taken from reserves that either did not exist already or did not arise as expected due to the company’s failure.
Whilst it is less tax efficient to take a salary, if company directors have any concerns about the continued availability of distributable reserves for the financial year to come, the safest course of action would be to opt to do so and to then regularly review how the business is performing, so that they can switch back when conditions allow.
For advice and assistance on the above issues, or any other corporate recovery matter, please contact Jim James at jim.james@wardhadaway.com or call him on 0191 204 4220.
