In my experience as a Chartered Accountant, one of the areas that cause the most significant confusion for new clients is drawings. In particular, the question of “… if I pay taxes on dividends, why don’t I pay tax on drawings?”. So in this short article, we are going to look at this question.
If you would like a quick answer, it’s no. If you would like to know why then please read on.
What Are Drawings?
Drawings are the withdrawal of equity (also called capital) from a business that an owner has built up over time. We disclose drawings transactions through the statement of financial position (or balance sheet).
Now let’s take this apart so we can better understand what we are dealing with.
Drawings, Equity and No Tax
We don’t pay income tax on drawings because the owner is withdrawing capital or equity. In accounting, capital and drawings equity mean the same thing. Generally, most tax jurisdictions do not tax the movement of capital, although gains on capital are.
In our case, we are not dealing with either gains or income with drawings. However, we need to be careful and ensure we deal with capital contributed or income for which tax has already been withheld. We do not want to be drawing income from the business, treating this as “drawings”, and avoiding income tax.
So how do we ensure that drawings are really drawings? Well, that will have to wait for another article, which I will hopefully link around here, where we look at the drawings account and proper debits and credits. This article will look at how different business structures and, in particular, companies and the treatment of salaries and dividends through this type of account.
Just a short article today looking at the essential question do you pay income tax on drawings from a business? The quick answer is no; no income tax is due on drawings because it is not an income or gain back to the owner, but rather the movement of capital already invested into the business, be it a sole trader, partnership or company.