2 Mins
A liquidator has a duty to investigate the affairs of every company they are appointed on. Of particular interest are payments to directors. This is the third in a series of articles that look at the different types of payments that may be made to directors, what a liquidator will investigate and the consequences. This article looks at Drawings.
Drawings are amounts withdrawn by directors which are not salary/wages or business expense repayments. It is common for directors who are shareholders to take out money as drawings rather than salary/wages for beneficial tax planning reasons. Drawings create an overdrawn directors loan balance, or will reduce a credit balance. At the year end, it is possible for company profits to be used to declare dividends which can be offset against the DLA balance to reduce or clear the amount which is due by directors. The dividends must be declared properly.
An example of dividend interaction with DLA.
Mr Smith is a director and sole shareholder of a company.
Mr Smith calculates that he needs £4,000 a month to meet his personal living costs. Mr Smith is paid a salary of £1,000 per month and £3,000 is debited to his DLA. By the end of the company’s financial year the director’s DLA is overdrawn by £36,000.
When the annual accounts are finalised, the company made a £40,000 profit. These profits are subsequently declared and paid as a dividend to Mr Smith as the sole shareholder. Mr Smith would receive a credit to his DLA of £36,000 and a further payment of £4,000.
The director continues with the same level of drawings for the following financial year. The company makes a loss of £50,000 during the year, due to challenging trading conditions and a significant bad debt. Accordingly, the company is not able to declare a dividend to shareholders.
The company trades for a further 3 months but due to increased trading losses, mounting creditor pressure and severe cashflow problems, the director seeks advice from an Insolvency Practitioner. Mr Smith concludes that there is no option but to cease trading and place the company into liquidation.
At the date of insolvency Mr Smith’s DLA has an overdrawn balance of £45,000 (15 x £3,000) which he is personally liable to repay to the company.
It is inappropriate for directors to reclassify any prior drawings as salary ahead of any insolvency event. This will likely be challenged by the liquidator and considered director misconduct. Any misconduct reported to the Insolvency Service could lead to the disqualification of directors.