Directors beware: taking remuneration as dividends is not without risk
Taking remuneration as a salary and dividends is common practice, particularly amongst entrepreneurs and family businesses, where directors are also the owners of companies. It can be far more tax efficient than a salary and bonuses. However directors beware – this common piece of tax planning may not suit everyone.
Typically each month a small salary is taken to cover national insurance contributions and the rest is taken as dividends.
At the end of the year the company’s accountant will then review profits for the year and re-categorise some of the dividends as salary if there are not sufficient reserves to cover the dividends paid during the year. During the year PAYE and NI will be paid on the salaries paid and returns made to HMRC recording the dividends, all entirely properly.
The question that arises is:
What if the company does not have sufficient profits that year and falls into insolvent liquidation? Will the liquidator, or a court, accept that the dividends can be re-categorised as salary?
If not, the dividends will be repayable. A recent Court of Appeal decision ruled that, in this situation, dividends when paid are in law dividends that therefore cannot be re-categorised.
Under the Companies Act, dividends can only be paid if they are justified by the last audited accounts, or later management accounts if those management accounts do show sufficient distributable reserves.
In the case neither the last audited accounts nor the subsequent management accounts, of the company involved, showed sufficient distributable reserves and so the dividends were deemed unlawful and had to be repaid. The Court was not prepared to accept that the historic practice of re-categorising dividends as salaries and the intentions of the directors was sufficient to “cure” the dividends as salary.
Interestingly in this case it was accepted that the directors concerned were working full time in the business and that the overall remuneration they took (aggregating salary and dividends) was not in any way improper. If the directors had been paid fully by way of salary (with no dividends) then they would not have been forced to repay those salaries.
The clear lesson for directors who are implementing this piece of tax planning is that if there are any doubts over the solvency of the company they should consider moving to pure salary remuneration, and stop dividends all together.
The case considered by the Court of Appeal is Global Corporate Ltd v Hale  EWCA Civ 2618