Directors Remuneration – wing it or plan it?

In our experience, too many shareholders don’t understand how their remuneration works, which inevitably leads to irresponsible decisions or an unexpected consequence.

An article like this is too generic to provide the perfect solution for your business, but here are some key considerations that we encounter on a regular basis.

1) What is the family structure?

A family business with more than one generation in ownership and/or more than two brothers in ownership together is complex, as different stages of life and different lifestyles can create very different income requirements. For a more complex ownership, a simple, structured and fair remuneration policy is essential to preserve family relationships and avoid confusion.

2) Tax efficient or commercially viable?

Everyone wants to pay less tax, but it is rare that the best tax solution is also the most commercially or practically sound solution. The traditional model of a small tax-efficient salary topped up by dividend is well-established, but not always the best option, especially with Corporation Tax increasing to 25% in 2023. Sometimes, an attempt to facilitate a good tax outcome for one shareholder may compromise the interests of the company or other shareholders.

3) Alphabet Shares

Another traditional remuneration planning exercise is to give each shareholder their own unique class of shares, enabling the flexibility of paying different dividends to each shareholder. However, consideration should be given to the fairness of this approach – are minority shareholders adequately protected, and is there a clear policy on how dividend decisions are made?

4) Income and Drawings

An understanding of the difference between income (money earnt) and drawings (money taken) is essential for all shareholders. Some accountants work on the basis of declaring enough income for each shareholder to cover their drawings and tax from the business. We fundamentally disagree with this approach, which essentially means that the shareholder that takes the most, gets the most. Income should be calculated on the basis of a structured and fair remuneration policy. Drawings should be based on what is available to be drawn down. The remuneration policy needs to have a solution for exceptional circumstances in which a shareholder may need to drawdown an extra lump sum, so that the other shareholders don’t lose out. 

5) What should a remuneration policy look like?

There are many ways to deal with this, but in our experience, there are six fundamental streams of income:

• Salary – reward for work done. This may or may not be done through the payroll, but would be a commercial viable and pre-agreed amount that is in the budget.

• Incentive Scheme – for some shareholders, particularly in sales, an incentive scheme may also be appropriate

• Vehicle – whether a company car or a vehicle allowance, having a fair and equitable solution for all shareholders is important

• Interest on Capital – any shareholders fund held in Directors Loan Accounts or elsewhere should be paid a proper rate of interest as a return on the investment.

• Rent – if the property is owned outside of the company by the family, a commercial rent should be paid to the owners

• Dividends – the final dividend is an annual decision based on the performance of the business and the ongoing cash-flow requirements of the business.

This list is by no means exhaustive, but gives an idea of how a remuneration policy can be constructed, and how streams of income can change over time to ensure financial security for older shareholders, and incentive for younger and more involved shareholders.

Our observation is that a poorly planned (or non-existent) remuneration policy will eventually lead to a problem that may become very costly in terms of time, money and relationships. It is well worth the difficult conversations to get expectations and structures in place ahead of time.