Small companies: disclosure of transactions with directors
In recent months ICAEW has received a number of queries from members about the disclosures that small companies need to make about transactions with directors. This article provides a brief reminder of the regulatory background and highlights some of the current issues under consideration.
The disclosure requirements
Regulations issued in 2015 require small companies to disclose material transactions entered into with their directors and other related parties which have not been concluded under normal market conditions. Details can be found in paragraphs 1AC.34-36 of FRS 102 (which are derived from the regulations).
FRS 102 defines a related party transaction as a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged. Disclosures must include the amount of such transactions, the nature of the relationship and other information necessary for an understanding of the entity’s financial position. Information about transactions may be aggregated according to their nature (except where separate information is necessary for an understanding of the effect of the transactions on the entity’s financial position). There is no requirement to disclose the names of the related parties.
Normal market conditions
In some instances, it will be fairly obvious that a transaction has not been concluded under normal market conditions. For example, where a company sells a fixed asset to a director at a significant discount. In other instances it will be more challenging, for example in relation to directors’ remuneration, discussed below, where we have heard a range of views on what constitutes the most appropriate approach.
Although not specified in company law, FRS 102 paragraph 1AC.35 is clear that relevant transactions for these purposes include directors’ remuneration and dividends paid to directors, leading to questions about how to determine whether remuneration is paid under normal market conditions. It is not unusual, for example, for a director in a small company to be paid a relatively low salary and to also receive dividend payments, sometimes for tax planning reasons and sometimes to better manage cash flows. Many owner-directors receive what some might consider to be below market-rate salaries, but the level of salary may reflect what the owner-managers consider the company can afford to pay.
So, taking account of the small company context, are such transactions concluded under normal conditions, not requiring disclosure?
Not everyone thinks so. Some consider that directors must have been paid a normal commercial rate for their services for transactions to have been concluded under normal market conditions. In other words, a director would have to be paid the going rate for someone providing those services to a similar business in a similar market in an arm’s length transaction. This market rate could be much higher than the salary paid to many small company owner-directors.
The determination of whether transactions entered into with directors and other related parties have been concluded under normal market conditions has proved one of the more difficult issues faced by small companies moving to FRS 102. What is clear is that, ultimately, deciding whether or not an individual transaction has been concluded under normal conditions will always be a matter of judgement for the directors and, where applicable, the auditors. It would therefore be sensible to consider documenting the rationale behind the decisions taken in this area.
Finally, it is worth noting that where there is uncertainty about whether or not a transaction has been concluded under normal market conditions, a company might choose to disclose all transactions with its directors, making it clear that the disclosures include all material transactions whether or not concluded under normal market conditions. FRS 102 paragraph 1AC.35 suggests that small entities adopting this approach will still be compliant with company law.
Nigel Sleigh-Johnson is Head of the Financial Reporting Faculty, which is currently drawing up guidance on this topic for members.
Practicewire, September 2017