Explaining the Confusing World of the Current Account

The most frequent conversation with any client goes something like this:

“You tell me I’ve made a profit of $100,000 and I need to pay tax of $23,920.  You also tell me ‘you’ve declared a shareholder salary of $100,000 to me – where is my salary and where is that profit?

There’s nothing in the bank and I’m confused.”

Then the accountant warbles on about current accounts and the new business owner can be left frustrated (putting it mildly).

So here goes with our best Beany explanation:

Current accounts are like a bank account that you have with your company.  They are used to report on all the money you ‘deposit’  into the business and all the money you withdraw from the business.

It can feel like you are your company, sometimes. But the reality is that the company has its own legal status and the current account shows the movement of money between the two entities, you and your company.  This can be particularly significant where the company is owned by more than one person.

  • You put money into the company to get it going or boost it + Funds introduced
  • You take money out of the company to live on – Drawings
  • Amount Owing to you/Owed to the Company = Current Account Balance

So far, so relatively straightforward.

At the end of the year, Beany looks at the profit of the company.  This is calculated as all the sales you’ve made less all the claimable expenses.

This is what you will have to pay tax on.

You have a lower tax rate than your company (usually) so Beany will ‘declare’ a salary out to you.  All this means is that we move the profit from the company into your current account – the ‘bank’ owes you the salary.

So let’s look at an example of this ‘bank’ account, the confusing current account:

You deposit $50,000 to start your business $50,000 $50,000 owed to you
In the first year, you withdraw money to live on $75,000 $25,000 owed to your company
At the end of the year, Beany declares a salary
(moves the profit from the company to you)
$100,000 $75,000 owed to you
In the second year, you withdraw money to live on  $120,000 $45,000 owed to the company
At the end of the year, Beany declares a salary
(it’s less this year as your profit was lower)
$40,000 $5,000 owed to your company 

In this scenario, you are now in ‘overdraft’ with your company and you will hear the words that “you have an overdrawn current account.” At this point, it is legally required to pay interest on the overdrawn amount so typically we add this to the calculation which further increases your overdraft.

All this means is that you have spent more than the company has made which will put strain on the business and therefore we advise against it.

Recap:

  • You do not pay tax on your drawings.
  • You do pay tax on your profit.
  • Theoretically, you can take any amount out as drawings – but if you take more money than the company is making, you will end up with an overdrawn current account.
  • In the unlikely event that the company folds and you have an overdrawn current account, then you may have to pay tax on the overdraft (as the IRD will ‘deem’ it a dividend).

An overdrawn current account is almost always a warning sign of pressure so, if you hear this, take it seriously and make time to understand what’s going on.

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