Drawings & Shareholder Current Accounts

Drawings and shareholder current accounts are often misunderstood by business owners. Here is the lowdown on these two important things in your business.

What is a Shareholder current account?

Probably the easiest way to look at this is to view the shareholder current account as a running balance of all money taken out and all money put in by you as a shareholder. Think of it as a bank account that the shareholder takes out with the company.

You can spend the money from this ‘bank account’ by having the company pay for your personal expenses. We call this Drawings. Like a bank account, if you keep spending more than you’re entitled to, you are going to go into overdraft. This situation is known as an overdrawn shareholder current account or debit shareholder current account. Inland Revenue rules say that this is a benefit to the shareholder and therefore the company must charge interest on the overdrawn amount at rates published by them. Consequently, this creates extra taxable income in the company as it’s shown as interest received in the company’s profit and loss report. Importantly, the other side of this transaction is a debit to the shareholders’ current account which makes it further overdrawn – so a vicious cycle!

Where can I find my shareholder current account balance?

Find this within your company financial accounts in the Statement of Financial Position (aka Balance Sheet).

Where exactly the amount is presented within this report depends on your situation. It will be presented under current liabilities if you are owed money by your company as it is a debt to the company. However, If you have taken out more than you are due, the amount you owe the company will be shown as a company asset. Note, this is technically repayable by you to the company this is why it is shown as an asset.

Where can I find out what’s exactly included in the shareholder advance account?

Often there is an accompanying schedule in the financial accounts that provides a detailed breakdown of what’s included in the shareholder current accounts. This will show any amounts you have introduced, non-PAYE salaries credited, dividends credit and drawings taken.

Are drawings tax-free?

Clients often say “my mate at the pub told me that I can take drawings from my business and not pay tax”. This may be correct, but there is another half of the story.

Again we will use the shareholder current account being a bank account analogy. You can spend the money from the ’bank account’ but after a while the ‘bank account’ needs deposits going into it. This stops it from going into debit or overdraft. The easiest way to top up the shareholder current account is to transfer some of your personal money into the company bank account – but you started the business to make and take money out of the company right?

How do I stop the shareholder current account going into debit?

The two main ways that you top up the shareholder current accounts are year-end Shareholder Salaries and Dividends.

Non-PAYE Shareholder Salaries

Non-PAYE shareholder salaries are book-entry salaries that your accountant puts through at year end. The key difference between them and normal PAYE salaries is that they don’t go through the payroll system. This means that they don’t have the monthly tax cost like a PAYE salary. However, the shareholder will have tax to pay in their individual name via provisional tax or terminal tax.

Dividends

Dividends are a way for companies to pay past profits out to shareholders.

How do dividends work?

Once the dividend is declared, the after-tax amount is credited to the shareholder current account. The shareholder then can take drawings on account of this as cashflow allows.

But what about the tax on a dividend?

Some business owners know that dividends come with imputation credits. This is a credit for the tax that the company has paid on its profits in the past.  What’s important to remember is that when a company pays out a dividend its accompanied by cash cost at the time you pay out the dividend. The company has paid tax at 28% but needs to pay a dividend with a total of 33% tax credits – the balance being the 5% cash cost. So when people say companies pay less tax than everyone else, while correct, it’s really only a timing issue.

How is the dividend taxed in the shareholders name then?

When the profits come out of the company and will have tax credits associated of 33%. If the shareholder has income over $180,000 then they will end up paying 39% on the dividend. They claim the 33% tax credit already paid and but need to pay an extra 6% tax on the dividend!

Learn more about dividends here: Dividends and Imputation Credits

Summary

So drawings being tax-free is correct but it’s only because there usually needs to be some taxable income to the shareholders to enable the drawings. Therefore, the point is that you need to pay tax sooner or later. The tax being paid will either be in the individual’s name when a shareholder salary is credited or when there is a dividend credited.

Business Like NZ has been providing professional yet affordable tax and accounting advice to the Auckland region for years! If you still have some questions, please contact us at the office or your call your client manager direct.