‘Deemed Dividends’ Warning
22 December 2009
Posted by: Author: Wouter Scholtz
‘Deemed Dividends’ Warning
Help a subsidiary in its hour of need – and pay tax on the loan!
The common practice of one subsidiary of a holding company making a loan to another may prove costly going forward, as the loan may attract Secondary Tax on Companies (STC), levied at 10% of the loan amount.
STC is payable not only on ordinary dividends, but also on deemed dividends—transactions treated as tantamount to dividend distributions for tax purposes. It’s generally understood that if you make an interest-free loan to an associate of a shareholder, the amount may be treated as deemed dividend, and the lender subjected to STC. When one subsidiary lends money to another, the latter qualifies as an associate of the former’s shareholder—the holding company. This is the basis of the STC exposure.
Directors of the subsidiary making the loan might have a false sense of security from an exception to the deemed dividend rules, which provides for an exemption from STC on loans made between companies in the same group.
The difficulty is that the exemption in respect of intra-group loans is qualified by an exception, in terms of which an STC exemption will only be granted if any reduction in the lender's profits, arising from the advance of the loan, is matched by an increase in the borrower's profits.
The qualification is difficult to understand, and is often misunderstood or ignored. Pardonably so, because it makes sense only if you understand how the granting of a loan may give rise to the reduction of the profits of the lender, with no corresponding increase in the profits of the borrower.
If the accountants of the subsidiary making the loan were to conclude, subsequent to granting it, that they might experience difficulties recovering the loan in the near future, or at all, they would have to ‘impair’ the loan in the subsidiary’s books.
If the loan was for R2 million, for example, they may conclude that the amount should be carried on the balance sheet not at R2 million but at, say R750 000. The amount by which the loan is written down—R1.25 million—will be treated as a charge against profits, which would therefore be reduced.
In the books of the subsidiary receiving the loan, there will be no reduction or ‘writing down’ of the loan amount on the basis that, whatever its difficulties might be, it remains legally liable to pay the full amount. Because the loan is written down in the books of the subsidiary making the loan, thereby reducing its profits, and because there is no corresponding reduction of the loan amount in the books of the other subsidiary, the transaction will attract the qualification to the STC exemption.
The exposure to STC is in part attributable to the fact that the intra-group loan was made on an interest-free basis. If interest had been charged at the official rate—currently 8%—another exception to the deemed dividend rules would have applied.
If there is any real likelihood of a delay or difficulty in recovering an intra-group loan after the due date, the borrower should be subjected to interest at the statutory rate.
Source: By Wouter Scholtz (Taxbreaks)