Directors warned about taking early dividends
Company directors who take a proportion of their salaries as
dividends could be building up a significant liability if things do not go
according to plan, warns insolvency experts Cranfield Business Recovery.
For many years directors of companies have been taking a minimum salary and then drawing money from their company on a monthly basis in anticipation of a dividend being declared at the end of the financial year. These additional drawings are posted to a director’s loan account which is repaid at the end of the year when the declared dividend is credited to the account. Dividends can only be declared out of retained profits and therefore what happens if, at the end of the year, there is not enough profit to cover the overdrawn director’s loan account, or the company enters an insolvency process during the period? In such situations the director will have to pay back the drawings even though in reality, such drawings were really salary.
If profitability is in question, the answer, according to
Cranfield, is to incur the extra PAYE income tax and National Insurance by
drawing a full salary rather than build up an overdrawn director’s loan account
which may not get repaid via dividends at the end of the year.
Profitability is one of the key indicators of whether a
company is about to hit troubled times. Towards
the start of this year the insolvency body R3 stated that 37% of small
businesses were experiencing decreased profits, and almost a quarter of small
firms were regularly using their maximum overdraft. These worrying statistics suggest
that many business owners could be liable to repay their overdrawn director’s
loan accounts when profits do not achieve expectations and dividends cannot be
declared.
Tony Mitchell, managing director of Cranfield Business
Recovery said: “During uncertain times, my
advice to all owner directors is that if there is any doubt at all about the
solvency or profitability of your company, consider very carefully whether the
savings that can be made in PAYE Income Tax and National Insurance
contributions are worth the risk of having to repay an overdrawn director’s
loan account.”
Cranfield states
that other factors indicating a company may be struggling include cash flow pressures
and staffing pressures as a result of pay cuts and freezes or redundancies
creating discontent within the workforce, which can ultimately affect the
viability of a business.
Tony concludes: “Similarly, accountants and financial
advisers should review all their clients’ arrangements, where directors receive
minimum salaries and take drawings in anticipation of future dividends. They need to evaluate the solvency of client
companies and where necessary advise clients to pay additional PAYE Income Tax and
National Insurance, even if this incurs more costs for the business. In the long run, this might actually work out
as a better option for directors.”