Debit loans granted to directors of companies or members of closed corporations
28 March 2013
Posted by: Author: Doria Cucciolillo
Source: Doria Cucciolillo
Tax implications may arise in the event where a member of a closed corporation or a director of a company owes money to such an entity. Both parties involved may experience additional tax implications depending on the conditions of the loan.
Income tax implications
The first issue that needs to be considered is whether or not interest was levied by the close corporation or company on such a loan. In the situation where there is an employer-employee relationship between the respective parties and no interest is levied on the loan, a fringe benefit will arise from the transaction. This will also be the case where the actual interest charged is lower than interest at the official rate.
A situation like the above will result into an additional tax liability for the employee since he or she will be taxed on the fringe benefit. Therefore an amount equal to the outstanding balance of the loan (at the end of the employee’s year of assessment) multiplied by the difference between the official interest rate and the actual interest rate that was charged, must be included in the employee’s taxable income as a fringe benefit. The official interest rate is equal to the South African repurchase rate plus one percent. The South African repurchase rate is fixed by the South African Reserve Bank (SARB) and is the rate levied by the SARB when lending to other banks.
If, however, the director or member carries on a trade and the borrowed funds are applied in the production of income, he or she may qualify for a deduction in terms of section 11(a). Therefore, the net effect of the transaction on this individual’s taxable income will be neutralised.
No fringe benefit will arise if the loan does not exceed an amount of R3 000 during any period within the year of assessment or the funds are supplied to the employee for purposes of his future studies.
Additional taxes that arise from interest free (or low-interest) loans include dividend tax. If a loan is granted by a company to one of its directors, or their connected persons, the interest free portion of the loan will constitute a deemed distribution made to the director concerned.
The deemed dividend will be calculated as the balance of the loan at the end of the company’s year of assessment multiplied by the difference between a market-related interest and the actual interest charged on the loan. This portion represents a deemed distribution and will attract dividend tax at a rate of 15%. A market-related interest rate is defined as the South African repurchase rate plus one percent.
The deemed distribution will only occur if the loan was granted to a director of the company or a connected person of such director (by virtue of a share held in the company or close corporation). If the person who obtained the loan, is a non-resident or a company, no dividend tax implications will result from the interest free (or low-interest) loan.
Since the distribution does not represent an amount in cash but rather the benefit of an interest-free loan, it constitutes a dividend in specie. Therefore, the company will be liable for the dividend tax which is payable on the transaction. The payment date of the dividend is considered to be the last day of the company’s year of assessment. Dividend tax on this transaction must be paid over to the authorities before the end of the month following the month in which the dividend was declared.
This provision does not apply to the extent that the loan was deemed to be a dividend subject to secondary tax on companies (STC).
Let us assume the following situation: On 1 March 2013, a company granted a loan of R500 000 to one of its directors, Mr X. The company charged interest on this loan at a rate of 2%, while the official interest rate was 6%. Assume that the year of assessment for both the company and Mr X ends on 28 February 2014. The full amount of the loan was still outstanding on this date.
Since the official interest rate exceeds the actual interest charged on the loan, a fringe benefit arises that must be included in Mr X’s taxable income. Therefore, an amount of R20 000 [R500 000 x (6% - 2%)] will be taxable in Mr X’s hands. The interest expense that was actually incurred by Mr X during the year of assessment may be allowed as a deduction for income tax purposes.
In order to obtain this deduction, the borrowed funds must be applied by Mr X in the production of income through a trade and all the requirements of section 11(a) must be fulfilled. In such instance, Mr X will be entitled to claim a deduction equal to R10 000 (R500 000 x 2%) for income tax purposes. In addition, Mr X will also be allowed to claim a deduction equal to the fringe benefit that is included in his taxable income1. This amount is deemed as interest actually incurred by Mr X in the production of income. Therefore an additional amount of R20 000 will be allowed as an income tax deduction from such income.
The company involved must include the actual interest received, amounting to R10 000, in its taxable income. The full amount will be subject to tax since a legal person does not qualify for an interest exemption. Any expense that results from this transaction will not be deductible in terms of section 11(a), unless the granting of loans forms part of the company’s business activities.
The interest free portion of the loan will also give rise to a deemed distribution for dividend tax purposes. The above constitutes a dividend in specie valued at R20 000 [R500 000 x (6% - 2%)]. Payment of the dividend is deemed to have occurred on 28 February 2014 (the end of the company’s year of assessment). Therefore the company must pay dividends tax of R3 000 (R20 000 x 15%) over to the South African Revenue Service before the end of March 2014.
It is thus clear from the above that debit loans granted to members of a close corporations and directors of companies hold tax consequences that must be considered by both parties.
List of References
Koekemoer, van Schalkwyk, Wilcocks & de Swart, SILKE: South African Income Tax 2013 (Durban:
LexisNexis Butterworths, 2012), 383.