This post is about deposits on business bank statements, not personal bank statements. Many businesses have been penalised because they cannot explain the source of deposits into their bank accounts.
The post lists some sources of deposits into the bank account and outlines what the business should do to ensure that the deposits are not treated as business deposits.
Production of bank statements
The first step in establishing a business’s tax liability is to determine the sales for the year. It is essential to note that tax reporting is conducted annually, corresponding to each calendar year. Hence, tax audits are done for each year of income.
Bank statements for the business’s bank account or accounts are some of the records that the business is required to maintain and produce for examination to an authorised tax officer under the tax law.
Under the tax laws, it is an offence to refuse to produce bank statements. The business must provide bank statements upon request.
Note that a bank statement is required for income tax, value-added tax, domestic excise tax, customs, and many other taxes. For customs, they are required due to post-clearance audits.
Let us examine a bank statement
If you review your bank statement, you will see various columns. One of the columns is the deposits column. This column records the money deposited into the bank account.
Tax officers want to know the source of your deposits. In normal circumstances, deposits should be from sales, specifically sales proceeds from credit and cash sales for the entire year of income.
But is that the case?
No … there are deposits from elsewhere. It is only in very special circumstances that a bank statement will have deposits from sales proceeds only.
What are some of the sources of the other deposits?
There are many sources of deposits into a bank account. However, this list will only examine a few.
Payments for previous years’ debtors
Business debtors from the previous year or years may decide to make a payment during the year of income under examination. These payments will be reflected as deposits in the bank statements.
Formal loans
These are loans from banks, microfinance institutions, financial institutions, or other lenders. The loans may be for investment. For example, the loans may be for the purchase of machines or the construction of buildings. The loans can also be used for day-to-day operations of the business.
Loans from family
Sometimes, businesses obtain loans from close family members and relatives, such as parents, siblings, and children. The loans typically do not have interest and may also not have a specified repayment period.
Loans from informal lenders
In every market, there are informal lenders, such as shylocks. These loans will have specific repayment time frames. The loans normally bear interest. The loans are often deposited into the bank statements.
Loans from other businesses
Occasionally, some companies rely on business-to-business loans. The loans are often soft loans, whose repayment period may be short or unspecified. The loans are deposited into the bank accounts.
Capital injection by shareholders or directors
When businesses lack adequate resources, they may ask current shareholders and/or directors to invest additional capital in the company. This may be either equity capital or debt financing, such as loans.
Re-banked cheques
Many times when cheques from customers or clients bounce, the businesses are asked to re-bank the cheques. The re-banked cheques will appear as deposits for the second time and as many other times as they are re-banked.
Inter-bank cash transfers
Some businesses hold bank accounts at different banks. Sometimes, there are inter-bank money transfers. The transferred money appeared as a deposit in the source’s bank account and will also be reflected as a deposit in the destination bank account.
Inter-account cash transfers
Businesses often maintain multiple accounts at the same bank. Occasionally, movements are found across the accounts for various reasons. Every time money is transferred, it is reflected as a new deposit in the destination account.
Bank errors
Like every organization, banks make mistakes. Sometimes, money is deposited into the business account, and the owner is unaware of its origin. The equivalent of the money is then removed.
Tax refunds
Sometimes the tax authorities refund tax to businesses. Such refunds may include VAT refunds, taxes paid in error, or overpaid taxes, etc. The tax refunds will be deposited into the business bank accounts.
Insurance claims
Business makes an insurance claim when necessary. When the claims are paid, the money is deposited into the business account.
Court awards
Businesses seek court redress when aggrieved. The court awards, if monetary, will be deposited into the business bank accounts.
Investments returns
Businesses also invest in other businesses for profit. When other businesses make profits and distribute them, the business will receive investment returns. The return is in the form of dividends. The dividend will be deposited into the business account.
Sale of business assets
Occasionally, businesses sell assets to raise funds or because they no longer need them. The proceeds from the sale of the assets are deposited into the bank accounts.
Donations
Some very generous benefactors of the business, including the government, may decide to donate some money to the business. The donations are deposited into the bank accounts.
What should businesses do about the deposits from other sources?
There are several proactive steps that a business can take to ensure that deposits from other sources are not treated as sales deposits. The following are some of the steps.
a) Note the source of each deposit – create a column and indicate where each deposit came from.
b) In the case of capital injection by shareholders and directors – maintain updated shareholder’s director’s current account.
c) In case of loans, have documentary evidence of the sources of the deposits. The same treatment for formal loans is applied for informal loans.
For example, there is a need for at least 5 letters to prove there was communication and the loan is an official loan to the business.
i. Minutes of the Board of Directors meeting where it is decided that the business requires money and from where to borrow.
ii. Letter of request to the person or persons from whom the business money was borrowed.
iii. Letter from the lender indicating their willingness to lend the money to the business and the terms of the loan. The letter should also include the loan period, interest rate, and other relevant details.
iv. Letter from the business agreeing to the terms and conditions of the loan.
v. Letter from the lender informing the business that the money has been dispatched.
d) Frequent bank reconciliations are performed weekly, monthly, or after some time.
By undertaking the above steps, the business will not have problems explaining the source of extra deposits. Hence, the deposits will not be treated as taxable income.
Disclaimer
This post provides a general overview and guidance, and does not constitute professional advice in any way. Hence, www.taxkenya.com, Its owner or associates do not take any responsibility for the results of any action taken based on the information in this post or for any errors or omissions. Kenyan taxpayers must always rely on the most current information from the KRA. The tax industry in Kenya is very dynamic.
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