The ability of a director to draw remuneration is dictated by a company’s constitution. If the constitution stipulates that a director has no entitlement to remuneration then they will be unable to claim. If there is no constitution then a director will need a contract of employment, written resolution or shareholder agreement to have an entitlement to remuneration. While an accountant will work with a director, who has an entitlement to receive remuneration, to minimise the client’s tax position within the confines of the Income Tax legislation, there can be occasions when such a structure does not benefit the client
This article discusses some of the anomalies associated with the remuneration of a director of a company in adverse circumstances.
Workers Compensation Schemes
In South Australia, the Return to Work Act 2014 (SA) sets out the provisions for compensating workers who suffer a work injury or dependents who are dependent for income on a deceased worker who suffered a workplace fatality. The compensation is based on the Average Weekly Earnings (AWE) of the worker paid during the twelve-month period prior to the injury by the employer under whose employment the injury occurred.
The legislation is complex and there are a number of exemptions for certain classes of workers and contractors. While a director may be a working director of a company that does not necessarily mean that they will be entitled to AWE if they are not paid a wage from which tax has been deducted and in respect of which superannuation payments have been made. Hence a distribution of profits to a director as a shareholder of the company or the director as a beneficiary of a trust of which the company is the trustee may not be classified as a wage.
This can substantially reduce a working director’s entitlement or the entitlement of dependents. While the incidence of injury is not normally contemplated, there may be benefit in giving consideration to payment of even a minimum wage to a director. This is particularly relevant if the work carried out by a director is in an industry that has a higher incidence of accidents such as truck driving.
It should be noted that WorkCover legislation is state based legislation and varies from state to state. The comments in this article relate to South Australia.
Exemptions in insolvency for a Director remunerated as an employee
The Corporations Act 2001 (Act) makes provision for the employees of an insolvent company to be paid in priority to the unsecured creditors of the company.
Where a director is paid as an employee and therefore has tax deducted from their wage and superannuation paid, the director, their spouse and any relative (as defined in the Act) are considered excluded employees.
This means that any excluded employee is limited to a priority of:
- $2,000 for unpaid wages and superannuation; and
- $1,500 for unpaid leave entitlements.
The balance of all other entitlements rank equally with all remaining creditors.
The Fair Entitlements Guarantee Act 2012 (FEG) is generally available to employees of a company which has gone into liquidation and where the liquidator has insufficient funds to meet the priority claims of employees. The specifics of the mechanics for making a claim are outside of the scope of this article but it is relevant to note that excluded employees are excluded from claiming pursuant to FEG.
Director paid via distributions
As noted above, a director is often not formally employed by a company but rather receives compensation from distributions in their capacity as a shareholder of the company or beneficiary of the trust.
Where a director is paid via distribution, the usual accounting treatment for the distributions/drawings taken throughout the year is to record them as a loan payable by the director. When the distribution is made, the loan is credited with the distribution, thereby reducing the loan payable.
Where such an arrangement can cause issues for the director is in the event of a liquidation where the drawings exceed the distributions. This can leave a debt payable by the director that a liquidator is required to pursue should the company be placed into liquidation. Such action to recover the loan may include taking steps to make the director bankrupt.
In addition, the existence of director debit loan accounts may cause issues with creditors voting favourably on any proposal for a restructure via either a voluntary administration or a small business restructuring.
When working with a director to determine how they may be paid it is important to consider the pros and cons of the elected payment method taking into consideration the industry and its risk from both a personal injury and financial risk perspective.
Article by Hillary Orr (Consultant) and Travis Olsen (Director) – Adelaide