Directors of North East businesses that have been hit by the coronavirus pandemic need to stay compliant with the rules around how they draw income from their companies.
That’s the advice of Alexandra Withers, North East chair of insolvency and restructuring trade body R3 and an associate solicitor in the insolvency department of Short Richardson & Forth Solicitors, as a growing number of regional businesses that have been partially or fully closed by Covid-19 begin to reopen.
A significant proportion of directors of limited companies take their income in dividends, rather than as straightforward salary, so that it is subject to lower rates of tax.
These dividends must be drawn from the company’s ‘distributable profits,’ which are comprised of the difference between the company’s accumulated realised profits and its accumulated realised losses.
Directors must also consider their company’s future financial requirements before declaring a dividend and cannot simply pay a dividend even where distributable profits are currently available if they know the company has a large liability falling due shortly that it would then not be able to pay. Directors could be liable if they pay a dividend in an ‘imprudent’ manner.
With the pandemic not only eating into many businesses’ cash reserves but also likely to impact on the revenues they can generate in the coming weeks, Alexandra Withers is recommending that directors take a realistic view of the best way to draw their income.
She says: “The business insolvency regime has been relaxed to give viable businesses hit by the pandemic the chance to recover, while the support mechanisms put in place by the Government will give firms at least a chance of overcoming any temporary issues, but this doesn’t mean that their directors have been given carte blanche to act as they please.
“Receiving dividend payments instead of taking a standard salary is a common practice, but this approach could create serious problems for individuals whose businesses become insolvent, problems which would be piled on top of everything else associated with this happening.
“If a struggling firm does become insolvent, the insolvency practitioner appointed over it has a duty to look at the directors’ conduct, and also at whether there are unlawful dividends that should be repaid, as part of maximising the funds available to pay creditors.
“While straightforward salary payments are unlikely be targeted by an insolvency practitioner, dividend payments would very much be in their sights should they not have been taken in accordance with company law.
“There is always an element of forecasting which goes into the availability of funds for dividend payments, but directors have to be more stringent in their financial planning today than ever before or risk the personal and commercial consequences.
“While it is obviously less tax efficient to take a salary, if company directors have any concerns about the continued availability of distributable profits for the new financial year in light of events in the wider world, the safest course of action is to seek advice and to regularly review how the business is performing as the months progress.”