Dividends vs Directors Salary – Consequences If The Company Does Not Achieve

There are many directors of owner managed Companies who take a minimum salary (up to the National Insurance limits) and draw the rest of their pay as dividends.  By doing so, they benefit financially as they do not have the National Insurance contributions to pay and there are other small tax advantages. 

It is normal in these circumstances for the directors to draw an amount per month and class this as director’s loan and then at the end of the year, declare a dividend and offset the two.

If you do receive your pay in this way, you must make sure that you do it in accordance with the Companies Act. 

For dividends over £10,000 you need to have a shareholders resolution approving the loan, together with a memorandum detailing the particulars of the loan, such as the amount, nature, purpose and the extent of the Company’s liability.

For a dividend to be lawful, it must be taken from your accumulated realised profits. 

This is all well and good if the company is doing well and making sufficient profits, but what happens if the company is not doing so good?

You cannot backdate a dividend declaration to make the loan payment look like a dividend payment.  This is fraud – don’t do it!

So what happens if the Company does not declare a dividend at the end of the year?

You could end up with a substantial director’s loan account at the end of the year, which is money you owe to the Company.  This will mean that you have worked for a whole year and the only pay you have to show for this is less than say £8,000.

The director’s loan account is also taxable at 20% if it is not paid back within 9 months of the end of the Corporation Tax accounting period, adding extra financial burdens on the Company.

An even worse scenario is that the Company fails and enters into some type of insolvency.  Even if the Company enters into Liquidation, Administration or a Company Voluntary Arrangement ‘CVA’ you will have to pay this back as you owe the Company this money.  In the event of this happening it is usual for settlements to be reached to relinquish this debt.

My advice is to take a wage that you can live off throughout the year (through the PAYE scheme) and leave dividends until your accounts have been drawn up if you can demonstrate that there are sufficient reserves and funds available to draw them.

If you are worried about the financial position of your company, we would be happy to advise you.  Our initial advice is free with no obligations.  Please contact Claire Foster (Licensed Insolvency Practitioner) on 01302 965485 or request a callback using the forms on our website.