Tax Pooling - An unexpected source of working capital
There’s a source of funding available to most businesses seeking finance that they do not know about...
One of the most difficult aspects of operating an SME via a company structure is getting your head around shareholder current accounts. If you just remember that the company is a separate and distinct person from you the shareholder, then any transaction you make with the company (cash drawings, private motor vehicle expenses, personal expenses paid for by the company) will be recorded in your personal shareholder’s current account.
As accountants, all too often we find that when we complete the end of year accounts for an SME company, if the shareholder has drawn more money from the company than they have put in or had credited, their shareholder’s current account becomes overdrawn. IRD can tax that overdrawn current account and ‘deem’ it to be a taxable dividend. The easy work around for this is for the shareholder to pay interest on the overdrawn current account to the company, or we can ‘credit’ the shareholder with part of the company profit and call it a ‘shareholder’s salary’ to reflect the work done during the year. That shareholder’s salary then goes into your personal tax return and tax is paid in the normal way.
Currently, if you are a shareholder employee of your own company and you draw a PAYE salary, any further profit made by the company cannot be allocated to you as a shareholder salary without PAYE being deducted. The difficulty here is that if you’ve drawn that profit out of the business in the form of cash drawings, your personal account (current account) can sometimes be overdrawn.
However, help is at hand. Once enacted, the 2016 May Bill will allow the more sensible approach to be taken whereby those who receive PAYE salaries can also have a shareholder’s salary allocated to them without PAYE being deducted. And it’s about time! A further practical aspect of the proposed change is that when shareholder salaries are credited to a shareholder employee, the credit can go back to the first day of the year. This can then deal with any overdrawn current accounts and thereby reduce mandatory interest charges, or worse, deemed dividends.
The proposed rule is an elective one. In other words, your accountant will elect for you to have both PAYE and non-PAYE income during the year. However, if you choose to opt out of paying PAYE on all shareholder salaries (and instead have a salary credited at year end by your accountant) you have to stay out of the full PAYE regime for 3 years. You can opt-in to PAYE at any time, if you are not deducting PAYE from any payments. For those operating via a ‘Look-Through Company’ (LTC), PAYE salaries remain the order of the day. These changes will be effective from 1 April 2017 for most people.
Currently, if your company pays a dividend to a shareholder, tax paid by the company previously (an imputation credit) is attached to that dividend at 28%, and a further 5% resident withholding tax is paid by the company. This means for a shareholder who receives a dividend and pays income tax at 33%, there is no further tax payable.
Unlike shareholder salaries which can be credited back to a shareholder’s current account on the first day of the year, dividends are taxable income to the shareholder when they are paid or credited. So if your personal current account in the company is overdrawn (because you’ve been taking drawings), crediting a dividend back to the current account might not correct the balance.
However thanks to the tax friendly 2016 May Bill, if you now pay a dividend after 31 March 2017, and it’s all fully loaded with tax credits (imputation credits and RWT), it will credit back to the later of the first day of the tax year, or the day your current account became overdrawn.
Probably more for the accountants than for our clients; there are some positive outcomes for those facing debt remission issues. Debt remission is an overly technical term used extensively by tax people to show others how clever they are. In simple terms, if you owe me $100, and I say don’t pay me, I have technically remitted the debt payable by you. You have gained a benefit, and Inland Revenue will tax that at your personal tax rate.
The changes proposed in the May 2016 Tax Bill will ensure that if a partner in a partnership or a shareholder in a close company (including an LTC and qualifying company) remits debt to their entity, that will not give rise to income to the partnership or company, respectively. It also means that where you may have old dormant companies hanging around which have balances owing back to shareholders, you can now strike them off without having any concerns about debt remission arising. And don’t worry also about the accounting treatment. If you book the debt remission as income and it flows to retained earnings, IRD has been very concessionary and said that any accounting income arising from a debt remission is going to be treated as available subscribed capital (ASC) on winding up. So you will need to keep a record (put it in the Notes to the Accounts) that a portion of your retained earnings arose from a debt remission and is therefore ASC on winding up.
There are also some really good options for dealing with inter-company balances. As long as the overall economic wealth of a group of companies doesn’t change, inter-company loans can now be remitted without creating income to the borrowing company. This will certainly strengthen the balance sheets of the borrowers and make the inter-group debt much cleaner.
Indeed, good news Mr. May – you will agree.
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