There are some specific rules relating to operating companies and personal expenditure that catch people out. One of the biggest mistakes I see is people assuming that since they did the work on behalf of the company, the money in the company bank account is theirs to spend right? Wrong.
Companies are separate legal entities therefore assets owned are the companies’ not the shareholders.
During the year you take drawings or buy personal items through the company bank account. This is recorded as a debit to the shareholder current account (SHCA). When your accountant declares a shareholder salary at the end of the year, this is recorded as a credit to the SHCA. They should offset each other.
A SHCA is like a loan between the company and the shareholder, and a debit (overdrawn) balance is subject to interest charges to comply with Fringe Benefit Tax (FBT) rules. If at the end of the financial year, if the SHCA is overdrawn, the shareholder is charged interest by the company at the FBT rates set by the IRD (currently 8.41%). This creates taxable income for the company but is not tax deductible for the shareholder, therefore creating more tax to pay.
If the closing SHCA balance is in brackets in the accounts, this usually means it is overdrawn and you will be paying more tax than you need to.
There are other things that debit the SHCA, such as personal insurances and paying personal tax from the company bank account. Year-end adjustments done by the accountant also create a debit, such as private use of vehicles and rent (if a shareholder is living in the farmhouse rent free).
How to fix this?
Only take what you need out of the company bank account and minimize personal spending from the company bank account. For example, paying for groceries out of the company account, it can be hard to keep track of how much you are drawing from company account.
Set up a company savings bank account, rather than transferring savings into a personal savings account. You may need to transfer money back into the company savings account before the end of the financial year to correct the debit balance (check with your accountant).
Review your personal expenditure, and if you are consistently drawing too much, set a personal budget and stick to it.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
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