Owner-managed businesses (OMBs) face changes to tax year-on-year that put strain on their companies, which can limit the rewards that being an entrepreneur can offer. In a worst-case scenario for a business, a company director will enter an insolvency process and attempt to make a claim from the Redundancy Payments Service (RPS). Brett Barton, Business Recovery and Restructuring Partner, discusses the issues directors may face in this scenario and the importance of a structured remuneration package for directors.
Historically, being a business owner and taking risk in business was rewarding. Subject to having a profit generating limited company, there was an ability to structure remuneration packages for tax efficiency, by taking a relatively nominal salary under PAYE and taking the remainder of your income in dividends.
The taxation of dividends changed back in 2016, with the introduction of a dividend allowance and the removal of the dividend tax credit. This was changed further in 2018, by which time the dividend allowance had reduced to £2,000, and the main corporation tax rates had increased to 25% from April 2023. For the current tax year, the dividend allowance has fallen further to £500.
How does this impact directors?
There have been longstanding issues of the RPS accepting directors’ claims in an insolvency situation such as differentiating them from a standard employee and believing they have financial foresight in the performance of the company. More recently, claims from directors have been rejected purely because their pay was lower than the National Minimum Wage (NMW). This seems to be on the basis that the RPS is accepting that a director is an employee for these purposes if they are paid at least NMW.
It is important to note this is based on our experience of dealing with the RPS on claims made by directors in an insolvent scenario. PKF Smith Cooper are not corroborating that their approach is consistent with the law.
What does this mean from a business restructuring perspective?
In the most successful claims from the RPS, directors hold a formal contract of employment with the company when they enter an insolvency process and can demonstrate a level of salary for a three-year period at a commensurate market rate.
Overall, making a claim as a director from the RPS is challenging and there are many more factors that the RPS consider that have not been discussed as part of this article. However, given the changes to personal taxation and the high rate of corporation tax, this has marginalised the benefits of having a low salary and high dividends remuneration model compared to the position prior to 2016.
Is it time to reconsider your remuneration packages?
Profit extraction through dividends does not work for every business structure. If you or your business are questioning your remuneration packages, we are here to help. It may be more appropriate, considering recent tax changes and our RPS experience, to have a revised remuneration structure. Get in touch with a member of our tax team today to see how we can assist you in this.
If your business is struggling financially and you have continued to take drawings potentially creating an overdrawn director’s loan account or have any other questions about how the RPS process claims in insolvency proceedings, get in touch with a member of the Business Recovery and Restructuring team for an initial consultation.
