[Question] Substantial debit member's loan account

[trevorp]

Hi everyone. Hope all is well. I need your expert advice.

I'm currently the bookkeeper for a small close corporation that provides road freight services that is managed by a husband and wife.

The wife is the only member of the close corporation.

They run the business from their private residence. The bond of the private residence is registered in the name of the husband & wife.

The CC pays the bond on the private residence, which is accounted for as follows:

Dr - Members Loan Account: Home Loan (Balance Sheet)
Cr - Business Bank Account (Balance Sheet)

The wife receives a small salary from the CC (from which PAYE and UIF is deducted and paid over to SARS), which is accounted for as follows:

Dr - Salaries (Income Statement)
Cr - Members Loan Account: Member1 (Balance Sheet)

The wife pays various personal expenses from the business bank account, which is accounted for as follows:

Dr - Members Loan Account: Member1 (Balance Sheet)
Cr - Business Bank Account (Balance Sheet)

The "Member Loan Account: Home Loan" has been allowed to grow to a substantial debit amount (R400,000+) over the last couple of years.

To make matters worse, they recently purchased a new vehicle (in the name of the husband) but the CC pays the instalments, which is accounted for as follows:

Dr - Members Loan Account: Vehicle Instalments (Balance Sheet)
Cr - Business Bank Account (Balance Sheet)


My question is, how do I resolve this substantial debit member’s loan account? Do I increase the salary of the wife? Do I draw up a rental agreement between the CC and the husband and wife whereby the CC rents office space in the house at a market related price? Do I declare a "dividend" of R400,000+ ?

Any constructive, helpful advice would be appreciated.

Regards
Trevor

[Blurock]

They may experience problems when the business applies to a bank for finance. The negative loan account means that they have withdrawn money from the business which may leave them with negative equity in the business, possibly technically insolvent and also with tax implications. This is not the way to run a business, even if it is your own.

[SSS100]

As long as they will not be needing any bank quarantees or finance, I would not be surprised if this loans will subsequently written off in future
I maybe wrong, but I think it's a way to get something out of th business without increasing members salaries due to personal tax implications,

[trevorp]

Hi guys, thanks for the replies.

I agree this is not the way to run a business and it has lots of negative implications but what is done is done. How do I resolve the issue?

I've tried explaining to them that they have to keep their personal expenses and business expenses separate but the husband doesn't seem to understand the issue. The business is making money and he can withdraw money from the business as he sees fit. I've given up on trying explaining to him that he can't.

Like I said, what's done is done. How do I resolve this going forward?

I was thinking of telling them, they have to increase the salary the wife (as a member of the CC) earns and maybe let the husband also earn a salary from the CC (for providing operational services). These increased salaries would be used to pay for their personal expenses and to decrease the substantial debit member's loan account.

Any suggestions?

[CLIVE-TRIANGLE]

There are only two choices, as you said, which is salary or dividend. Presumably it qualifies as an SBC? If so the choice is easy; dividend. If not then you need to crunch the numbers.

Doing a rental agreement merely shifts the tax burden from the cc to the member.

Two questions:
1. You wrote:
"The wife receives a small salary from the CC (from which PAYE and UIF is deducted and paid over to SARS), which is accounted for as follows:

Dr - Salaries (Income Statement)
Cr - Members Loan Account: Member1 (Balance Sheet)"

I presume this salary is not actually paid ?

2. In the case of the recently purchased vehicle that is registered in the member's name, in whose name is the finance agreement? (I presume the member also)

[trevorp]

Hi Clive,

Yes the CC qualifies as a “small business corporation”.

The member is a natural person.

The member does not hold any shares/members interest in equity of any other company/close corporation.

The gross income for the year does not exceed R14 million.

And not more than 20% of the total of all receipts, accruals and all capital gains consists collectively of investment income and income from rendering a personal service.

To answer your questions:

1. The salary is not actually paid to the wife. Like I mentioned, Salaries are debited and Members loan credited. The wife then pays personal expenses from the business bank account which is accounted as debit members loan account, credit business bank account.

2. The finance agreement is in the name of the husband. The husband is not a member of the CC.

[CLIVE-TRIANGLE]

Trevor,

The single membership does pose some problems. I presume also that the husband is not a remunerated employee and pays no paye? (Normally the case)

The primary issue you need to deal with is eliminating the debit loan. If not, there is a good chance that SARS will deem the absence of interest as a deemed dividend. The portion that arose prior to the 2013 tax year itself is at risk of the same treatment; the capital amount. The provisions for this are in the Act and it is therefore actually incumbent on the cc to treat it this way and failure to do so can attract penalties (though that is scarce).

If you think past the accounting, what has actually happened? The owners have extracted income without declaring it and without paying the requisite tax. That's the reality.

As always there are more than one solution.

One is to pay the husband a salary also, like the member, to offset against the loan. You can do this because they are connected persons for this purpose.

Another is to prepare a loan agreement that charges the required interest and makes provision for repayment.

Another is to declare and pay a dividend, all or in part. That presumes there is current or accumulated retained earnings to enable this.

And of course there is a combination of some or all of the above.

Because natural persons do not pay tax on a linear scale, whereas the cc does, you will need to crunch some numbers to get the most tax effective mix of solutions. You should probably look to redeem the loan by offset over a reasonable period, perhaps 5 years?

I should have asked; are you the Accounting Officer of the cc?

[trevorp]

Clive,

That’s correct; the husband is not a remunerated employee of the CC. He has a full time job at a company from which he earns a salary. The business is “something on the side”. His wife is the only member of the CC. She does the basic admin functions for the CC and he oversees the operation.

As you said, the primary issue is dealing with the substantial debit loan account and the “withdrawals” from the CC. As you rightly say it is extracting income without declaring it and paying the requisite tax on it. I’ve tried explaining that concept to the husband but he doesn’t seem to grasp it and I don’t know how else to explain it to him or maybe I’m just not good at explaining it.

I’ll have to crunch some numbers and probably use a combination of the solutions. I was thinking of redeeming the loan over a period of time instead of “one go”.

No, I’m not the accounting officer of the CC. At this stage they don’t have an accounting officer. I’m a part time bookkeeper. I complete the bi-monthly VAT returns from the bank statements they provide me and the monthly PAYE returns. They've asked me to compile an Income statement and Balance sheet for the 2012 financial year for which the tax return is due at the end of this month. Their business income and expenses is fairly straightforward, it’s when they mix personal expenses and business expenses that things start to get murky.

[SSS100]

It's clear the husband does not want to pay tax or repay the money, he sees it as his way of getting something back from the business for all his efforts
Lets be honest here, we all know how much we hate the idea of starting a business, develop and run it only for the tax man to get more out of it than we deem appropriate

Ok, simple then...put it as loan, have the loan agreement and charge interest on it
That way it meets requirements
Then, he doesn't pay and it gets written off on future . Just like a business would write off a bad debt
Problem solved, the man is making it clear he is not prepared to pay tax or repay loan

[CLIVE-TRIANGLE]

SSS100, if only it were that simple!

Trevor, the reason I asked about the accounting officer is because in my experience one sometimes meets much resistance and you are then forced to accede to the client's wishes, let the predicted consequences come to pass, try not to gloat when they do, pick up the pieces and repair what you can. The alternative often is to lose the assignment.

You clearly know what you are doing, so I'd say trust you instincts.

[trevorp]

I was reading SSS100 suggesting and thinking; surely it can't be that simple :-) Surely writing a loan off has it's own set of requirements and consequences but like he said the husband sees it as his way of getting something back from the business for all his efforts he just fails to realise the consequences.

I was thinking to “pay” the husband a salary to start reducing the debit loan account, accounting for it as follows:

Dr - Salaries
Cr - Members Loan Account: Home Loan
Cr - Members Loan Account: Vehicle Instalments

I should just tell the husband he must not make an actual payment from the business bank account to himself because he already “earned” the salary.

Clive as you said, I’ll have to crunch the numbers and determine the most tax effective mix of solutions and as SSS100 said, the husband doesn’t want to pay tax but the husband will have to realise there is no way to escape tax and trying to do so can be disastrous.

I’m not familiar with the solution to prepare a loan agreement. How exactly would that work? Obviously the agreement would need to be in writing stating the required interest rate, term of the loan and repayments required, signed by the husband and the CC represented by the wife who is the only member but how does the accounting work?

For example,
The CC pays the first vehicle instalment of R8,000 on 01/03/2012. The vehicle is registered in the name of the husband and the instalment sales agreement is in the name of the husband. Assume the there is no opening balance. Accounting for it as follows:
Dr – Members Loan Account: Vehicle Instalments – R8,000
Cr – Business Bank Account – R8,000

Now I need to calculate the interest for the period of March 2012 on the loan. I calculate it as R8,000 x 6% / 365 x 31 = R40.77

Accounting for the interest as follows:
Dr – Member Loan Account: Vehicle Instalments – R40.77
Cr – Interest Received: Member Loan Account – R40.77

The following month (01/04/2012) the second instalment is paid by the CC.
I calculate interest for the period of April 2012 as R8,000 (first instalment) + R40.77 (interest March 2012) + R8,000 (second instalment) = R16,040.77 x 6% / 365 * 30 = R79.11

Is this correct? What happens even though there is an agreement, the husband doesn’t make any repayments? The debit loan account keeps increasing and the interest received keeps increasing. Surely this can not continue indefinitely and the debit loan account hasn’t been eliminated.

Am I missing something?

[SSS100]

My post, as much as it maybe inappropriate, is purely based on the practicality out there
Lot of people feel they are paying too much to the government and not getting any incentive for starting he business and of course creating jobs in this country as it currently stands
In that way, such people in that situation will rather not entertain the consequences sinario
And expect you the accountant/ bookkeeper to be more "creative" in dealing with such matters

I think the last solution posted will work, only if the husband will agree and understand that he will not be able to withdraw he salary, it's only created to deal with the loan account, to offset it

But, will he agree to that? I doubt it

[trevorp]

SSS100 what you say is true. Lots of people feel they are paying too much to the government and not getting any incentive for starting the business and creating jobs.

That's going to be the difficult part, getting the husband to agree to it. But he can either accept it or reject it and suffer the consequences when SARS does an audit.

[Dave A]

SSS100 what you say is true. Lots of people feel they are paying too much to the government and not getting any incentive for starting the business and creating jobs.

Given what my enterprise generates for SARS, the only way I stay sane is with the following outlook:
VAT - it never was your money in the first place.
PAYE - it's the employees' money.
Other payroll taxes - small potatoes compared to VAT and PAYE.
Income tax - at least it's only on profits (theoretically "money made", although in practice it doesn't work out that way, of course).

Yeah, I know - it's rationalising the issue and there are flaws in the logic. But it doesn't hurt nearly as much paying it over if you don't covet it

When I get the chance, I try to focus on "how do I make gov do a better job spending it" - at least when I've got enough time left in the day after thinking about how to make the damn money in the first place.

[SSS100]

The gov already have a good way to spend it Dave, it's called Nkandla upgrade
Sounds familiar?