Brenton from Tax Matters Talks
I am a chartered accountant and insolvency practitioner and I have helped lots of businesses with working cashflow pressures and liquidated companies who can’t survive these pressures.
As much as possible I push my clients to be on the payroll rather than taking drawings and receiving a shareholder salary at year end. Different accountants have different views on this (accounting end of day is an art not a science). The main two reasons for pushing for PAYE deducted salary rather than drawings are tax planning and reducing the risk of an overdrawn current account.
Drawings or Salary - Which is best?
If you are on drawings and a shareholder salary than you will often end up in the provisional tax regime. Basically, anyone who has to pay more than $2,500 at the end of year for tax will in the following year have to pay 105% of last year assessment. You can use tax pooling (will not cover here but accountant can explain) but most people end up paying provisional tax on 28 August, 15 January and 7 May. This gets very stressful for people as 15 January is a very hard date to come up with a large lump of cash, and 7 May is into the following taxation year and people struggle to understand who they are paying provisional tax for last year in this year.
If you are on PAYE salary, then the tax gets deducted each pay period and you don’t end up with the large lumpy provisional tax. Some clients continue to take drawings and do not actually take the salary that is declared, we simply pay the PAYE so tax planning is easier.
Being on a PAYE salary, even though the company is yours, does make raising finance easier as banks like to see regular salary rather than just relaying on business profits.
If you are receiving a PAYE salary for your living expenses and then only taking drawings for a percentage of profit, then the plan would be that there will be enough money left in the bank to pay year end tax. Doesn’t always work to plan with assets being purchased but helps.
Why accountants recommend drawings (but I don't)
When a company is not trading well the accountant will often advice the shareholder to stop paying PAYE and receive just drawings in order to save money. This works fine if the shareholder current account is positive and the company owes the shareholder money (a shareholder current account is basically your own overdraft with your company, its goes down when drawings made, up when funds introduced and up when year end shareholder salary or dividend is declared) but if the shareholder’s current account is negative (i.e. shareholder owes the company money) then this can get problematic if the company ends up in liquidation. The liquidators views this as an asset of the company and asks the shareholder to repay the money. Shareholder ‘s get very upset as in their view they were only taking drawings for work that was done and in effect it was salary. But until a shareholder salary or a dividend is declared the overdrawn shareholder current account remains an asset of the company.
Realise this is long winded but in essence these are the main reasons why I encourage business owners to be on PAYE salary rather than drawings.