May 19 2014
Be careful as there are some pitfalls
“If you are a company director it’s tempting, particularly in a closely held company, to withdraw funds for expenses and to pay yourself as and when you decide that you need money – without recording the reasons for your decisions. In many situations you may think that you are doing what’s best for the company, but you need to be aware that you are running the risk of being personally liable for the funds withdrawn.”
Money withdrawn from the company by you as the owner or shareholder that’s to be used for anything other than for the business is called ‘drawings’. These drawings can generally be categorised as salary or dividend payments or advances under your shareholder current account.
What are the pitfalls of this practice?
You need to be aware that in a liquidation your wages or salary may not be treated in the same way as would another employee’s wages. If you pay yourself more than a market salary or take more drawings than the actual business profit, you could be liable to repay the difference. A liquidator is required to realise the assets of the company and anything owed by you as a director is immediately payable. Any payments in excess of a reasonable and properly authorised salary are likely to be classified as advances under your shareholder current account and will be payable to the liquidator.
Be familiar with your company’s constitution
If you pay yourself a salary without passing the relevant resolutions and certificates¹ you may be in breach of the company’s constitution; ignorance is no excuse. Your company’s constitution could be more stringent than the minimum requirements set out in the Companies Act 1993, so it pays to check.
To safeguard yourself, you should consider waiting until your company’s annual accounts have been prepared before setting your salary. This allows you to record in your director’s resolutions that you have assessed the company’s financial status and can set a salary for the coming year that’s in line with both market rates for your position and the company profits. You could then instruct your lawyer to prepare the necessary company resolutions for you to sign.² If the payment is to a director, the Companies Act requires you as director to sign a certificate stating that in your opinion the payment is fair to the company and the grounds for that opinion. If you don’t bother, you risk becoming personally liable to repay the money that you receive to a liquidator.
The risk is even higher if you take drawings over your pre-approved salary for the year. In that instance you should reassess the company’s financial standing and pass resolutions that encapsulate the special circumstances for authorising a salary increase. That way you can avoid the trap of payments above your pre-approved salary being classified as shareholder advances or as unauthorised payments.
If the company’s profitability is marginal you should consult your company lawyer and accountant before going ahead with any payments to yourself.
Ambiguity – drawings or expenses?
At times company expenses may be difficult to distinguish from drawings. You should document every purchase and expense very carefully. For example, entertainment expenses may be reclassified as drawings if you have not recorded the expense properly. Ambiguity is not helpful in a liquidation setting. It can be surprisingly difficult to prove that items or costs relate to the company if you have not bothered to keep clear records. If there’s any doubt a liquidator will take the view that costs are personal.
It’s important to ensure that your shareholder current account is not overdrawn and that all salary or dividend payments have been properly authorised. Ensure at all times that you keep good records of not only transactions but also the reasons behind them.
¹ Director’s Resolutions, Shareholder’s Resolutions, Director’s Certificates authorising these according to the Companies Act 1993 ss107 and 161, and any further requirements of the Company’s Constitution.
² To save expense, your lawyer could prepare a precedent set of resolutions that you can easily use over and over again for other transactions.