Company Directors: salaries and renumeration

I recently shared insights on the duties of company directors. In my experience, conflicts often arise between directors and internal staff, and with directors and company shareholders. With good legal advice there are ways to mitigate this risk and also take action after the conflict has occurred.

Dividends vs salary

Separate to a director’s duties, another key issue on which there is little formal guidance relates to how a director may be paid for their services.

Many directors, particularly in small and medium sized companies, are shareholders as well, which makes them entitled to dividends. The temptation therefore is instead of taking a salary, director-shareholders take their renumeration in the form of dividends, taking advantage of the lower tax band.

The first thing to note with this arrangement is that there is nothing inherently wrong with receiving dividends as rewards; it is perfectly acceptable to take your director’s renumeration in dividends. However a process must be followed, or there is a risk that all dividend payments are automatically declared unlawful (this is also the case for any dividend payment, not just those in lieu of salary).

The dividends process

The Board of Directors must adhere to the below process, and document it in the board minutes:

• review the interim or final accounts and consider whether the company is making a profit;
• if the company is making a profit, then the Board must decide whether there are sufficient distributable reserves (i.e. funds which have not been or should have been allocated to other purposes) for the company to afford a dividend payment;
• if there are sufficient distributable reserves, the Board must decide the size of the dividend; and
• formally declare the dividend and record it in the minutes of the board meeting. Any dividends made by reference to interim accounts must be finalised and ratified in reference to the final year end accounts.

If the above process is not followed, or if it becomes apparent that the company is not making a profit or there are insufficient distributable reserves, any dividends declared are automatically deemed unlawful. In these circumstances, the dividend payment is reclassified as a loan from the company to the director and placed against their director’s loan account to be repaid.

So, whilst director-shareholders may take dividends as renumeration, this is only acceptable when the company is turning a sufficient profit to support the dividend payments. By contrast, it is always acceptable for a director to draw a salary as long as the company remains solvent.

The key thing to remember with both of these issues is that as a director the company comes first, it is its own legal entity and you are its protector. If a course of action is not in the company’s best interest, then your role as a director is to stop that course of action. Following all of the formalities inherent in being a director helps not only to orientate decision-making around this idea, but also serves as evidence that directors have fulfilled all of their responsibilities and duties to the company.

Need legal advice on any of the issues raised in this article? contact our Dispute Resolution team on 01227 763939.