If you’re a company director, you may be tempted to use the company’s funds to pay your own personal expenses. For example, you might be tempted to withdraw money to pay for your new boat, holiday, pay your mortgage or simply pay yourself a regular “salary”.
These type of transactions are typically called “drawings” but can often be classified as salary or dividends. However, whilst you think that what you are doing is reasonable, you are exposed to being held personally liable for the funds you have withdrawn.
Will you be held personally liable?
Company legislation is strict. You should note that if your company is “wound-up” (liquidated) these withdrawals would be subject to close scrutiny by the Liquidator. The Liquidator could (and most certainly would) demand that you repaid some, or all, of these funds. They would almost certainly make you personally liable for any excess salary paid above market rates or those that exceed the company’s profits.
A Liquidator is legally bound to collect monies owed to the company and, if necessary, sell the company’s assets.
Don’t ignore the Companies Act
If you pay yourself wages or salary, without preparing the relevant company resolutions and solvency certificates, you may be in breach of company legislation – or your company’s constitution. The law doesn’t allow ignorance as an excuse and directors can be heavily fined. It is a good idea to check your company’s constitution as it may be more stringent than the rules laid our in the Companies Act 1993. If payment is to a director, the Companies Act requires directors to sign a certificate of solvency noting that in their opinion the payments are fair and reasonable to the company and also the basis for their opinion.
Prevention is better than the cure
To help protect yourself,consider waiting until after you have prepared your company’s annual financial statements. This would enable you evaluate your company’s financial performance and position before setting yourself a future salary.
If your salary is in line with your company’s profits and market rate salaries, you should then record your decision, via a director’s resolution, that you have taken the decision after evaluating the company’s financial status. You should then instruct your chartered accountant to prepare the relevant company resolutions for you to approve.
If you don’t, you are at serious risk of being held personally liable to repay the amounts you have taken. That risk becomes even higher if your drawings exceed your pre-approved salary.
You should consult your chartered accountant if your company’s profit is marginal, before paying yourself.
Ambiguity will not help
Often, seemingly “legitimate” business expenses might be difficult to distinguish from drawings. It’s helpful to record your expenses diligently. If they are not recorded correctly, such as entertainment, expenses may be reclassified as drawings. Ambiguity will not be your friend during a liquidation.
If a Liquidator has any doubt, they will treat these expense as drawings. It could be very hard to prove other wise if you haven’t kept proper records.
It’s crucial that you maintain proper accounting records. It’s even more critical that you support director’s salaries with duly approved resolutions and paperwork. You should avoid excessive salary payments and ensure that your shareholder current account is never overdrawn. To help protect yourself, ask your chartered accountant to prepare a set of company resolutions that you can repeatedly use.