REMUNERATION OF DIRECTORS – ZOMBIE COMPANIES AND RTI
It has been a long established practice for company directors to be remunerated with a small salary and receive a monthly dividend. This practice may be a tax efficient method for profitable companies – but, is it the correct method for a company struggling to make profits?
We now increasingly hear the term zombie companies – R3 recently reported that there are at least 150,000 businesses currently able merely to service their interest charges and not to reduce the level of debt. The phenomena exists whilst interest rates are low and if there is an increase in interest rates, then many of these zombie companies will fail. The owners have no means of escape and are forced to continue to trade as the business is over leveraged.
If your client is one of these zombie companies or surviving rather than prospering it may be time to review how the directors are remunerated. The payment of a regular dividend in anticipation of profit is likely to cause the directors loan account to become overdrawn. With the introduction of Real Time Information (RTI) for payroll the flexibility of reviewing the method of the directors’ pay on an annual basis and adjusting as necessary has been removed.
A review of your clients’ remuneration packages should be undertaken and in instances where the company is borderline profitable, it may be beneficial for the directors to take all their remuneration as salary subject to PAYE. Whilst it may appear to be more costly from a cash flow point of view it ultimately may the cheapest option from the directors’ perspective.
If the company enters a formal insolvency procedure, the final balance sheet is likely to show an overdrawn directors loan account and insufficient profits having been generated to vote a dividend. The director will face a request to repay the overdrawn loan account which, in the director’s mind, will be his “salary” for the past 12 or 18 months. The argument that the dividend was in effect a salary will not be accepted. So, at the time that the company fails, personal guarantees are being called and there is no income, the director now faces the prospect of repaying his overdrawn loan account. It seems to be a complete shock to the directors as they have never previously understood the “other debtors” figure in the annual accounts and had not appreciated that this figure related to them.
It does seem that RTI has worked and did not suffer the anticipated teething problems. It is now only a matter of time until HMRC uses this real time information to collect the PAYE in a more efficient manner and the informal extended credit previously taken as a matter of necessity will come to an end. Zombie companies will soon feel increased pressure from HMRC’s collection procedures and it is therefore even more important that the directors pay is dealt with correctly as their chance of survival worsens.
The image of zombie clients may not be palatable, but steps need to be taken to ensure that the death of a zombie company does not have too great a personal effect on the directors because they failed to consider the implications of the method of their remuneration.
Dan Hennessy is a Chartered Accountant and Licensed Insolvency Practitioner based in the North West