Director’s salary ambiguity leads to £250K bill
Many businesses have faced financial stress during the pandemic. As the economy starts to open up, a cautionary tale of director’s liability suggests it would be a good time to review close company directors’ remuneration strategies, paying particular attention to directors’ loan accounts.
High Court decision
On 14 October 2021, the High Court released its decision in the case of Bronia Buchanan Associates Limited (In The Matter Of Bronia Buchanan Associates Limited (In Liquidation) [2021] EWHC 2740 (Ch)). The Court found that Ms Bronia Buchanan, the sole director of Bronia Buchanan Associates Limited, was liable to pay the liquidators of her company £286,421.45. These were amounts which Ms Buchanan claimed represented monies due to her for running the company.
How did this happen and what are the practical implications arising?
Directors’ remuneration and business performance in challenging times
Bronia Buchanan Associates Limited provided client representation for actors. It traded for over a decade, had eight employees, annual turnover reaching £500,000 and, at one time, more than 400 clients. In early years it also generated significant profits, topping £95,000 in one year.
But administration as regards director’s remuneration was untidy. For a number of years Ms Buchanan received a monthly amount by standing order from the company. The amount varied, but was in the range £3,000-£4,500 a month in some years.
Profitability fell off, though, apparently, amounts taken from the company by the director did not. The accountants appear to have treated the amounts as payments on account of future, anticipated dividends.
The director, on the other hand, appears to have assumed that the money was paid to her as compensation for her role as principal of the business; for time and effort expended.
With profits falling, the accountants ‘squared the books’ by charging the amount to the director’s loan account. Hopefully next year, there would be sufficient profits to declare a dividend to clear the loan account.
But the loan account balance kept rising.
Paying taxes where taxes are due
Clearly from a technical point of view, this leaves few options. If the director’s loan account is left outstanding more than nine months after the company year end, corporation tax is due under s455 CTA 2010. On the other hand, a declaration of dividends requires sufficient distributable retained profits, and payment of salary means accounting for payroll taxes.
In addition, both salary and dividends require proper approval.
The accountant adopted a somewhat lax approach initially, agreeing to ignore the s455 tax so long as the director signed a statement that the loan would be repaid within nine months.
The court quoted correspondence from the accountant advising:
‘In previous years, we have discussed this requirement {to pay s455 tax} and agreed to ignore on the basis that the loan accounts have been cleared. However it is now clear that that is not the case and it is not likely to be the case and I am not comfortable and l am not advising you to take this position any longer.’
The hesitancy as to what should be done about the loan balance was not resolved before HMRC issued a demand for immediate payment of tax arears, which the company was unable to meet. Realising that the HMRC demand could not be paid, the company looked at insolvency options.
By the time the company entered liquidation, the amount previously showing as director’s loan account had been ‘reclassified’ as ‘drawings’.
The liquidators claimed that the amounts shown as ‘drawings’ were actually payments to the director which needed repaying to the company. There was no option for a director to make ‘drawings’ from the company other than as a charge against their loan account. Directors can genuinely be paid salary or dividends and certain other amounts, such as approved expenses, but ‘drawings’ simply is not a legitimate category. Such monies represent a loan.
Remuneration for directors
In a last-ditch attempt to avoid liability to repay the amounts, the argument was advanced on behalf of the director, that she was due remuneration from the company on a quantum meruit basis. All that was shown in the accounts for a number of years was a basic salary of around £6,000. This clearly was insufficient remuneration for a working director. The balance of ‘drawings’, even if taken to represent a loan, should be set off against a counter claim for reasonable remuneration.
The court would not entertain this idea and the argument was defeated on a number of fronts. Following the decision in Global Corporate (Global Corporate Ltd v Hale [2018] EWCA Civ 2618) the court held that in a liquidation, any such claim for remuneration would need to be proved for in the liquidation.
To do this, the payments would need to be identified as amounts legally due to the director for services provided. They cannot simply be recharacterised as remuneration when it suits the recipient (per Re The Sky Wheels Group of Companies Limited [2020] EWHC). In addition, the company articles stated that the directors of the Company would be entitled to remuneration as fixed by ordinary resolution of the members from time to time. But there had been no such resolution.
All in all, there was no evidence that the amounts paid out had ever been intended to be remuneration. If they had been salary, then payroll taxes should have been accounted for at the time of payment. This had not happened. Neither had there been any declaration of dividend, though in the circumstances it would seem unlikely that there were sufficient distributable profits.
Conclusion
During the pandemic, some businesses have taken on additional borrowing, and it is not impossible that some of this money has been used, at least in part, to fund directors. While it is acceptable for directors to be remunerated for their services, such remuneration needs to be properly approved, and appropriate tax liabilities accounted for.
The situation in coming years may be challenging for some businesses and it is particularly important that advisers assist clients in being realistic about remuneration packages, providing guidance on how to keep within the rules. Untidy administration in this area is likely to unwind with potentially serious consequences.
