Can a Director's Salary be allowed to create a loss and negative Net Assets?

Can a Director's Salary be allowed to create a...

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I've inherited a situation where a Ltd Co in its first year has made a profit smaller than the Personal Allowance.

The proposal is to declare director's salary at the Personal Allowance level and create a loss and negative net assets.  Loss to be c/f against next year's profits presumably, and a 'going concern' note required.

Doesn't seem right.  Salaries are supposed to be paid yes?, but are frequently credited to the DLA - is this classed as "payment"?

Feeling a discomfort, I would have thought they would have made a law about this.

Replies (31)

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By johngroganjga
30th Apr 2014 16:08

Yes crediting a net salary to the DLA constitutes payment.  What in this sequence of events do you think should be unlawful?

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Replying to johngroganjga:
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By Gone Sailing
30th Apr 2014 16:21

Lawful ?

johngroganjga wrote:

Yes crediting a net salary to the DLA constitutes payment.  What in this sequence of events do you think should be unlawful?

Using the 2013/14 PA to create a CT loss to be utilised in future years - sounds too easy.

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Stepurhan
By stepurhan
30th Apr 2014 16:13

Credits to DLA

Credit to the directors loan account is classifiable as payment. This is accepted by HMRC as well.

Paying the salary now makes use of the director's personal allowance for the year, enabling them to take funds out later without tax consequence. As it will be the DLA that puts things into negative territory, a note saying the director will not seek repayment until the company has funds available should suffice. It is only if the company is underwater even before putting the salary through

Your issue is RTI. Unless the salary was paid and reported before 5/4/2014, it is too late to get it in for that year. Salary to personal allowance means salary above LEL and reportable under RTI.

EDIT : I am assuming the "unlawful" concern was creating a deductible expense related to the shareholder/director without an actual payment. This is distinct from external creditors, where chasing the company for payment is outside the director's control.

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Replying to leshoward:
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By Gone Sailing
30th Apr 2014 16:24

RTI

stepurhan wrote:

Your issue is RTI. Unless the salary was paid and reported before 5/4/2014, it is too late to get it in for that year. Salary to personal allowance means salary above LEL and reportable under RTI.

 

An Earlier Year Update can still be done for 2013/14.  Just done one.

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Scalloway Castle
By scalloway
30th Apr 2014 16:12

NI Secondary Threshold

There is nothing to stop this but is the company registered for PAYE? Paying up to the personal allowance will mean NI is payable. The NI Secondary Threshold for 2013/14 was £7,696 per year.

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David Winch
By David Winch
30th Apr 2014 16:18

I'm confused

Has the company's first accounting period already ended?

If so then the salary will presumably be credited to DLA in tax year 2014/15 and in the company's current (i.e. second) accounting year.  So the company will be showing a (small) profit in its first year & positive net assets in the Balance Sheet.

David

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Replying to memyself-eye:
By johngroganjga
30th Apr 2014 16:25

Bonus

davidwinch wrote:

Has the company's first accounting period already ended?

If so then the salary will presumably be credited to DLA in tax year 2014/15 and in the company's current (i.e. second) accounting year.  So the company will be showing a (small) profit in its first year & positive net assets in the Balance Sheet.

David

I assume what the OP means is that he company is going to vote a bonus now for the previous accounting period.  It will be in  accruals in the balance sheet and then credited to the DLA now when voted, which of course triggers the PAYE entry and the NI liability.

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Replying to memyself-eye:
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By Gone Sailing
30th Apr 2014 16:26

DLA Credit

davidwinch wrote:

Has the company's first accounting period already ended?

If so then the salary will presumably be credited to DLA in tax year 2014/15 and in the company's current (i.e. second) accounting year.  So the company will be showing a (small) profit in its first year & positive net assets in the Balance Sheet.

David

Company year ended Feb 2014.  By doing an EYU they can credit DLA in 2013/14.

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By TerryD
30th Apr 2014 16:25

Why do you say that the director's salary has created the loss? More likely it's not selling enough widgets that's done it!

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Replying to penelope pitstop:
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By Gone Sailing
30th Apr 2014 16:27

Good point

TerryD wrote:

Why do you say that the director's salary has created the loss? More likely it's not selling enough widgets that's done it!

 

That is a good point.

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By Richard Willis
30th Apr 2014 16:56

Surely

in EVERY company that makes a loss the directors' salaries have contributed to that loss, often a bone of contention when negotiating with workers that 'times are hard'!

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Replying to Glennzy:
RLI
By lionofludesch
30th Apr 2014 17:01

Surely

Richard Willis wrote:

in EVERY company that makes a loss the directors' salaries have contributed to that loss, often a bone of contention when negotiating with workers that 'times are hard'!

So have the workers' wages.  What's the point being made ?

No problem here.  Move on.

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Replying to Hhw:
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By Richard Willis
30th Apr 2014 18:15

I touched a nerve obviously!

lionofludesch wrote:

Richard Willis wrote:

in EVERY company that makes a loss the directors' salaries have contributed to that loss, often a bone of contention when negotiating with workers that 'times are hard'!

So have the workers' wages.  What's the point being made ?

No problem here.  Move on.

One point being made is that directors' remuneration contributing to losses is commonplace. The other, that seemed to touch the nerve, is that the directors have control over what they are paid whereas the workers do not!
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Replying to Wanderer:
RLI
By lionofludesch
30th Apr 2014 19:16

Nerve

Richard Willis wrote:

lionofludesch wrote:

Richard Willis wrote:

in EVERY company that makes a loss the directors' salaries have contributed to that loss, often a bone of contention when negotiating with workers that 'times are hard'!

So have the workers' wages.  What's the point being made ?

No problem here.  Move on.

One point being made is that directors' remuneration contributing to losses is commonplace. The other, that seemed to touch the nerve, is that the directors have control over what they are paid whereas the workers do not!

Fair point.  Although the directors often have different pressures restricting their pay.

No offence taken.

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David Winch
By David Winch
30th Apr 2014 16:59

Decision time

If a decision is being made only now to vote a bonus, can that be an accrued expenditure at the year end (in February 2014)? 

I appreciate the size of the bonus may be based on the company's profits for the year to February 2014, but that alone does not make it an accrued expense at that year end does it?

David

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Replying to Willow0405:
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By Gone Sailing
30th Apr 2014 18:15

Payment of Salary

fawltybasil2575 wrote:
Unfortunately, ever since the "9-month" rule was introduced, many people (including accountants) have omitted to realise that the bonus also has to pass the standard test of being a valid accrual, namely there being an express (or perhaps implied in some cases) commitment, at the end of the accounting period, to paying that bonus. Basil.

 

A previous post above established that CR DLA was payment.  Presumably this can take place at Feb Y/E and go in 2013/14 tax year.  Not sure why the conversation moved to Bonus and not Salary.

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By johngroganjga
30th Apr 2014 18:01

A bonus is an accrual if it is a reward for services rendered during the past period. I don't think it's too complicated really.

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By johngroganjga
30th Apr 2014 18:41

If you credit the DLA at 28 February you ipso facto create an underpayment of NI on 19 March. Client won't thank you. The right way is what I explained above. It's in accruals until voted (i.e. decided upon). The conversation has moved to bonus because that is what it is. Your client chose to take no salary but now, quite reasonably, wants a bonus.

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By JimH
30th Apr 2014 19:28

Are you suggesting backdating ....
.... after the end of an accounting period?

Each time a client wants me to re-write history where no discussion or decision had been made before yearend, I turn to my PAYE course notes from the esteemed Rebecca where I scribbled and highlighted the gem (paraphrased): get the formalities right at the time: reserve the entitlement to allow the inclusion in accounts for CT deduction - provided paid within 9 months. Don't trigger PAYE under RTI by specifying the amount; simply reserve the right to pay an amount to be determined at a later date dependent on ...

If the client didn't think of it in time, don't rewrite history.

Another thread of interest https://www.accountingweb.co.uk/anyanswers/question/accrued-directors-bo...

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Replying to Exfoliate:
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By Gone Sailing
30th Apr 2014 20:45

Accruing Not Backdating

JimH wrote:
If the client didn't think of it in time, don't rewrite history. Another thread of interest https://www.accountingweb.co.uk/anyanswers/question/accrued-directors-bo...

I think it is safe to infer that anyone who starts a business and starts trading expects to get paid, ie. salary not bonus.  If they've not got all the tax, Companies Acts, and a myriad of other regulations in place, doesn't alter their basic intention, written down or not.

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Replying to Exfoliate:
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By Gone Sailing
30th Apr 2014 21:01

Triggering PAYE might be more tax efficient

JimH wrote:
Don't trigger PAYE under RTI by specifying the amount; simply reserve the right to pay an amount to be determined at a later date dependent on

OK, but in this case the client is trying to utilise their 2013/14 PA, well at the Secondary Threshold as scalloway rightly says.

And in this case the CT loss created gives CT loss relief in its next year.  Hence my original question.  It's like rolling over a PA to the next year. It's the sort of thing one needs to be sure about the advice given.

Thanks for all contributions, it's getting late.

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By johngroganjga
30th Apr 2014 19:53

So the rest of the profession, apart from your good self Basil, has been getting it wrong for all these years.

The rewards to be given at a later date for services rendered during a period, are by definition a liability at the balance sheet date.

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Replying to Matrix:
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By Gone Sailing
30th Apr 2014 20:39

Accruals

johngroganjga wrote:
The rewards to be given at a later date for services rendered during a period, are by definition a liability at the balance sheet date.

Absolutely, or someone has rewritten the accruals basis of accounting: costs to be included at the earliest opportunity, not to mention adjusting post balance sheet events.

 

 

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David Winch
By David Winch
30th Apr 2014 20:31

I was wondering if IAS 19 applied?

Para 19.17

An entity shall recognise the expected cost of profit-sharing and bonus payments under paragraph 10 when, and only when:

(a) the entity has a present legal or constructive obligation to make such payments as a result of past events; and

(b) a reliable estimate of the obligation can be made.

A present obligation exists when, and only when, the entity has no realistic alternative but to make the payments.

It seemed to me that was not the case at the year end.

This seems consistent with IAS 37.14 to 22.

Para 37.18

Financial statements deal with the financial position of an entity at the end of its reporting period and not its possible position in the future. Therefore, no provision is recognised for costs that need to be incurred to operate in the future. The only liabilities recognised in an entity’s statement of financial position are those that exist at the end of the reporting period.

David

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Replying to lionofludesch:
By JimH
30th Apr 2014 21:04

Ever the diplomat @David
It is difficult when new clients come after company year end from much larger (and top x) firms and say they haven't thought about it yet, but it doesn't matter does it as it's always been dealt with as an afterthought.

Thanks for the IAS 19 & 37 refs; FRS12 has served well. But nothing beats actually bothering to dig out and quote chapter & verse.

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The triggle is a distant cousin of the squonk (pictured)
By Triggle
30th Apr 2014 21:12

My view is that bringing in a director's bonus paid within 9 months of the APE is more a provision than an accrual.

Provisions can be made for obligations that are created as a result of events that occurred within the trading period but will be incurred after the end of the period.

That's why we bring in a CT provision, a bad debt provision, an accountancy provision, audit fee provision etc. They do not exist at the balance sheet date but are obligations to be met in the future based on the trading activity of the company up to the balance sheet date.

I can't see anything in the BIM that suggests that an actual contractual oblligation has to exist at the end of the AP for a company to claim a bonus paid after the balance sheet date. It's only the 9 month rule that comes up.

Therefore, in my view, if the bonus relates to the director's performance during an APE then the bonus belongs in the accounts for that AP. Why he's getting a bonus for making a loss is neither here nor there - the company may have made an even greater loss without the input of the skills of the particular director - who knows.

This is unlike beneficial loans where there has to be an existing contractual obligation for a director to pay interest on a loan at the time the loan is made in order to avoid some or all of the BIK charge and you can't just go that route after the event to avoid the BIK.

 

 

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David Winch
By David Winch
30th Apr 2014 22:16

@Triggle

I would suggest that a provision for bad debts simply reflects the value of an asset (debtors) which are an asset of the company at the year end (although the provision may be based in part on information received after the year end concerning the valuation of that asset which existed at the year end).

The provisions for corporation tax & accountancy / audit fees reflect liabilities to meet costs which the entity had at the year end no realistic alternative but to meet (although actual payment was not due by the year end).

But if the OP's client is only proposing NOW a bonus payment for the year which ended on 28 February 2014 (which was actually the company's first year of operation) then that bonus is NOT a cost which, at the year end, the company had no realistic alternative but to meet.

As you put it "Provisions can be made for obligations that are created as a result of events that occurred within the trading period but will be incurred after the end of the period".  I would broadly agree with that.  But no event occurred within the trading period which created an obligation to pay the director a bonus.

If this was a company which habitually paid staff bonuses after each year end based on the profit for the year, then one could argue that the company at the year end had no realistic alternative but to pay a bonus.  But that is not the case with this company.

So an accrual for the bonus can only be made in the accounts for the year ended 28 February 2014 with a little help from the time-travelling Dr Who and some re-writing of history, IMHO.

The point is one of generally accepted accounting practice.  Since tax treatment follows GAAP (except when it doesn't) then the CT treatment follows the accounting treatment (i.e. no deduction in the year ended 28 February 2014).

David

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Replying to rsergeant:
RLI
By lionofludesch
01st May 2014 08:47

Overplayed

davidwinch wrote:

The provisions for corporation tax & accountancy / audit fees reflect liabilities to meet costs which the entity had at the year end no realistic alternative but to meet (although actual payment was not due by the year end).

But if the OP's client is only proposing NOW a bonus payment for the year which ended on 28 February 2014 (which was actually the company's first year of operation) then that bonus is NOT a cost which, at the year end, the company had no realistic alternative but to meet.

I'm not sure I agree with that analysis.  Following that logic, if there's an accountant on the board, capable of producing the accounts, there can be no accrual for accountancy costs.

It seems an over-restrictive interpretation to me.

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Replying to rsergeant:
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By Gone Sailing
01st May 2014 10:37

Matching

davidwinch wrote:
But if the OP's client is only proposing NOW a bonus payment for the year which ended on 28 February 2014 (which was actually the company's first year of operation) then that bonus is NOT a cost which, at the year end, the company had no realistic alternative but to meet.

Surely this is a "matching" issue?

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By TerryD
01st May 2014 10:41

I think John is right (as usual)

All company directors do the job because they intend to pay themselves for their services. Thus there is a constructive obligation to pay a salary and/or bonus. That obligation exists at the year end. The fact that the amount of the bonus can only be determined after the year end (when the accounts are prepared) does not alter that - it is simply using post balance sheet events to determine the amount of a liability that exists at the year-end (as we do with bad debt provisions, telephone accruals, etc.).

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Replying to pdtaylor78:
Stepurhan
By stepurhan
01st May 2014 10:53

What post balance sheet events?

TerryD wrote:
it is simply using post balance sheet events to determine the amount of a liability that exists at the year-end (as we do with bad debt provisions, telephone accruals, etc.).
Bad debt provision only uses evidence after the year end if this is indicative the debt was bad at the year end. As for accruals, these are not using post balance sheet events at all. What they are likely to use is information received after the year end. So if your year end is 31 March and you receive a quarterly bill to April, you accrue two thirds of that telephone bill. But, assuming even usage, if you had terminated your telephone line at 31 March instead you would have received a 31 March bill for two thirds of the amount. The cost has been incurred before the year end, the only "post balance sheet event" is the arrival of the bill to confirm what that cost is.

In fact, unless they provide evidence of a liability at the year end, post balance sheet events should not be adjusted at all. That is a basic accounting concept.

Going back to the salary, what post balance sheet event has occurred anyway. The director has realised they should have put something through. They did not decide before the year end to put something through. First year so no precedent for salary to be paid. Planning to be more than the available profits, so even arguing you had to wait after the year end to use profits as part of the calculation makes no sense. Very thin ice indeed.

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