The easiest way to think of it is a bank account for each shareholder in the company. Money comes in and money goes out. Either you have loaned the company some money or the company has loaned you money. It is critical to understand this balance and the implications this has; especially if the company owes you money and you are unable to pay your personal debts. In this type of situation, you are putting your company at risk if you need to call upon your loan to the company, but the company has insufficient funds to repay you.
Normally shareholders will put money into the company to start. This is usually referred to as working capital and is usually recorded against your shareholders’ current account. During the year, if the company’s cash flow is a little tight and you pay some of the company’s bills out of your bank account, we will treat these payments as advances from you to the company via your shareholder current account. We usually prefer that you transfer money from your personal account to the company account and then pay the company bills. This makes it easier to capture all expenses and makes it transparent that it is a company expense.
Transferring money from your personal bank account to the company bank account will also credit your shareholder’s current account. The more you credit, or contribute to your company, the more the company owes you money. If there is surplus cash in the bank account, you can draw on this cash tax-free. The credit balance is represented as a Liability on the Balance Sheet as the company owes the shareholder that money.
On the other hand, if your cash is a bit tight and you take money out of the business, we record these drawings and debit the shareholder’s current account. In turn, the shareholder’s current account balance decreases. Some shareholders take drawings regularly and this works precisely the same way. If you owe the company money, the current account will show as an Asset on the Balance Sheet.
As you can see, it works precisely like your personal bank account. If the company owes you money, the account will be in credit. If you owe the company money, it will be in debit.
Sometimes shareholders take more money out of the business than they have in the shareholders’ current account. We call this an “overdrawn current account”. The Inland Revenue Department (IRD) views this as a loan from the company to the shareholders. If it is a loan, it must attract interest – and so we must apply interest at the end of the year to comply with the IRD’s rules. If we do not charge interest, then this is perceived as being a benefit that the company has provided you which would be subject to Fringe Benefit Tax.
If the shareholders’ current account is overdrawn at an end of a financial year, there are a few ways that we look at to fix them. The three most common ways are.
- Transfer money into the company to repay the overdrawn amount.
- Declare a shareholder salary. The company will need to be in profit for us to declare a shareholder salary. This will then be income in the shareholder tax return.
- Declare a dividend that gets credited to the shareholder’s current account instead of being paid out of cash to the shareholder(s). This will be dependent on retained earnings, imputation credits available, and the company being in solvent position after the dividend has been paid.
If you have further questions regarding shareholders’ current accounts, please contact your trusted advisor at Bellingham Wallace.
Author – Graeme Wilson