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A company's accounts cannot be retrospectively adjusted to meet the convenience of its directors. The High Court made that point in ruling that the reclassification of a director's loan account just before a company entered liquidation was of no legal effect.
The sole director of the intermittently profitable company blamed its insolvency on third-party bookkeeping failures. At the last minute before the company entered liquidation, the six-figure balance of her director's loan account was reclassified as 'drawings'. That was on the basis that she had taken the money from the company as salary, rather than as loans. The company's liquidators launched proceedings against her with a view to recovering the sum concerned.
The crux of her defence to the claim was that she was paid £6,000 a year in salary, a sum that was not commensurate with a director who often worked 15 hours a day for a company with an approximate annual turnover of £500,000, eight staff and hundreds of clients. Payments from the erstwhile director's loan account should have been recorded as drawings of salary and she was entitled to retain them.
Ruling on the matter, the Court found that the reality of the situation was that it was at all times intended or hoped that the company would ultimately make enough money to declare dividends that would be used to cancel out the sum due on the loan account. Money had been withdrawn from the company as payments on account of future anticipated dividends and was never intended to be salary.
The purported reclassification of the payments as drawings could not alter the basis on which they had been paid or received during the company's prior trading periods. Were such retrospective accounting adjustments possible, the Court had little doubt that most company owners or directors would adopt a similar practice. They would simply approve salary payments to themselves below the Income Tax threshold and then make additional drawings in the hope of earning sufficient dividends by the end of the year to pay off any debt arising to the company.
The sums that had been advanced to the director, and not accounted for as either salary or dividends, came to £286,421. Notwithstanding her attempts, on advice, to re-characterise those payments as drawings, they remained due and owing to the company as a debt. She was ordered to repay the total sum to the company, together with interest.