Well, usually the company is making some profits and your accountants advise you to save tax by paying your directors a small salary and then you take dividends from the reserves of profits made in the past and current years. SO off you go taking money out of the business as instructed.
Although the advice is generally sound from a tax reduction perspective, when a company is performing well; it’s when things go wrong that directors can end up with serious personal liability problems.
Having an overdrawn director’s current account is actually a breach of the Companies Act 1985. All accounts filed at Companies House should refer to any overdrawn Current accounts as loans to the director concerned. You must try to get these paid back or reversed in subsequent periods as the Revenue will tax you on a fairly penal rate if you do not.
If the company has no distributable reserves, it cannot pay dividends. So if your company’s balance sheet starts a year with nil or negative reserves , then if you make no profit you MUST STOP taking dividends as soon as you are aware of this.
It is much better to pay yourselves through PAYE and pay the tax/NIC. If the company cannot afford to pay you GROSS then it is pretty much insolvent.
In liquidation the liquidator can demand that directors repay their overdrawn directors current account to the company for the benefit of the creditors. They can take legal action to make directors pay this or even make you bankrupt.
So you could lose your house if your directors’ current account is overdrawn and not recovered.
So here is an example case study / guide. If you need more detail call us now.
See if this rings any bells and then call us for help.
Mr Jones and Mr Smith set up a limited liability company based in London. It is a design and marketing company and they formed it in 2001.
Sales built quite quickly based upon the contacts in the marketing sector and the company grew to £1.2m sales. Their accountants told them that the company had made £80,000 net profit in year 1 and that this would be taxed for corporation tax purposes at roughly 20%.
So he advised them to leave their PAYE salaries at a lower level each month in year 2 and take dividends from the reserves and future profits.
This they did for a number of years and paid themselves quite well as the company was profitable each year.
Then that “something happened”.
Their biggest debtor went bust owing the company c£158,000. Silly to let that debtor take as much credit in my view, but their view was “after all the company was a well known big name customer and we never thought it would fail”. And it was good regular business for them so we understand why it got to be such a big debtor.
This led to a situation that was clearly not planned for. In 2006 the company had a bad trading year on top of the failed customer and so had to write the bad debt off. This made a huge loss for the year of £250,000. As a result the balance sheet then became negative (see insolvency test) and they saw the first flashes of a cashflow crisis looming.
So no further dividends could be taken AND the directors now had overdrawn directors’ current accounts to the tune of £70,000. With cashflow pressure mounting they came to KSA and said they needed restructure the company or close it.
This was our advice: consider the options, set out your objectives, look at the viability of the company and then make a decision to ACT. Call KSA in and we will set out the options in writing and in expert detail - that will help you decide.
A CVA was used and the current account problems solved? Want to know how? Call 01289 309431 now. See below for more details.
If the company entered a formal terminal insolvency like administration, receivership, voluntary liquidation or compulsory liquidation, then the insolvency practitioner/liquidator could have demanded that the directors repay the £70,000 back to the company for the benefit of creditors.
This could have caused them personal financial hardship and with personal guarantees to the bank of over £200,000 the last thing they wanted to do was liquidation or administration. Indeed it was likely that personal Bankruptcy would follow.
So we looked at the Go Options with them. (By the way we never charge for this detailed advice) and these included Trading Out, Trade Sale, CVA and or refinancing.
The key test is viability. We felt that one bad year and a huge bad debt did not equate to a bad business. Far from it this was a good business with dedicated directors and staff. So we said look at Go options and try and select the best option with our help.
We recommended that CVA would be the best solution and this was why.
The overdrawn directors current account liability would be “reversed”, in other words the payments would be treated as being net pay through the PAYE scheme. This of course generates a larger PAYE and NIC liability. But using the CVA the debt would be bound by the process. Along with reduction in people and managers (the lost contract meant that they had too many people) the company was forecasting a modest profit at best or just below break-even at worst.
So if you or your directors have an overdrawn current account and a company that is under real pressure then call us on 0800 9700539. As the above case shows we can save your business and help you as directors.
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