GUEST BLOG - Dividend vs Salary - Has the Balance Shifted

The Coronavirus Job Retention Scheme (CJRS) provided a much-needed financial cushion for vast swathes of furloughed employees and helped numerous businesses over the past few months.

However, one group has missed out on the Government's generosity – director/shareholders of owner-managed companies.

Many directors of small companies have been excluded from the CJRS because they have historically favoured dividends over salary. Does this mean the balance will shift the other way?

The pre-Covid advantages of dividends...

Before the pandemic, directors and shareholders of SMEs would typically be paid via a low salary topped up by larger dividends. This appeared to be a perfectly sensible idea because it reduced the amount of tax and NI they and the company would pay.

If shareholdings were split with spouses or partners, a substantial sum could be paid by a company with minimum tax liabilities.

... and the post-Covid disadvantages

When it comes to the CJRS scheme, directors and shareholders have encountered two major obstacles:

  1. The low salary

For most directors, the salary processed each month by their company payroll is roughly £800. With dividends out of the CJRS picture, that is the maximum monthly amount they can claim.

With this further reduced to 80%, the CJRS has left many directors with a salary of less than half of the National Living Wage.

  1. The RTI cut-off date

Rather than a monthly salary via payroll, some directors opt for an annual lump sum processed once a year at the end of March. Under the circumstances, the timing could not be worse.

To qualify for CJRS, an RTI submission should have been submitted to HMRC before 19 March 2020. Those directors drawing annual salaries missed the boat and simply did not qualify.

The plight of directors has not gone unheeded. The issue has been raised in Parliament, with MPs demanding the inclusion of dividends in the CJRS calculations. So far, these demands have been rejected.

Where are directors and shareholders now?

Where finances allow, directors have carried on drawing their regular monthly sum, topping up the furlough payment through additions to their loan account.

At present, those loan accounts are likely to be overdrawn, with the debt repayable to the company. Given the uncertain future, continuing to draw these excess funds may be unwise.

Under normal circumstances, the company would clear the overdrawn loan account by declaring a dividend after the annual accounts have been prepared. But these are not normal circumstances. After three months of little or no income, and with the future so precarious, there may be insufficient reserves to draw dividends for some time.

At some point over the next 12 months, indebted directors or shareholders will be required to repay their overdrawn loan accounts. If the debt is not cleared within the allotted timeframe and the company is continuing to trade, the overdrawn balance will incur a tax liability.

Should the company then fail, directors will find themselves personally liable for repaying the overdrawn loan account to fund payment to creditors.

So, what is the solution?

One option is to ride out the storm. After all, Covid-19 has been described as a `once in 100-year pandemic', and the Government is taking unprecedented steps to protect the economy.

But there is a more pragmatic option, which is to increase the level of salary so that more of the furlough payment can be claimed. The directors will increase the salary drawn from the company and reduce the amount of dividend declared. This will increase the tax liability for the company and employee, but it will provide income protection should something like this happen again.

Has the balance shifted in favour of salaries over dividends?

In our opinion, it is too early to say, as there are both practical and moral questions to consider right now.

Firstly, the high costs of the Government's rescue schemes will eventually need to be recouped. Could the dividend model come under the Treasury's spotlight as a chance to increase tax receipts or could employers' National Insurance be levied on dividends paid to employee/shareholders of SMEs?

Secondly, while everyone is entitled to organise their affairs to pay minimum tax, is there now a moral duty to pay a little more?

Over the last three months, the future has become more uncertain. Given the chances of a 'once in a century' event happening again, perhaps now is the time to think ahead about protecting your business.

About CVR Global

CVR Global is an independent firm of insolvency practitioners and forensic accountancy experts. They offer prompt, practical and cost-effective advice based on the needs of their clients.

Their teams are based in eight locations across the UK, and they have three offices overseas.

For friendly, accessible help with finding a workable solution, get in touch with CVR Global.