Tax considerations of debit loans
11 November 2015
Posted by: Author: Candice Mullins
Mullins (The Tax House)
closer look at the introduction of Dividend Withholding taxes and its impact on
It is certainly the sign of
the times that we as practitioners are seeing a significant increase in the
number of debit loan accounts present on the balance sheets of our small to
medium sized clients. The tax law with respect to these loans changed with
effect from 1 April 2012 with the introduction of Dividend Withholding taxes, or
Section 64E(4) of the Income Tax Act.
When determining what tax
treatment would be applied, it is imperative to consider why the debit loan
arose in the first place and very importantly, what interest the debit loan has
been subjected to for the entire year of assessment.
In an owner-managed
environment, it is logical that there could be two possible reasons, which could
have given rise to such loans:
- As a
result of being an employee of the company. Remember that a director of a
private company is "an employee” as defined as a personal services provider and
a labour broker, or
- Due to that
resident person holding shares in that company.
In the first instance, the
provisions of the Seventh Schedule would take force. One would have to
determine the cash equivalent of the low interest component of the loan. The
recipient of the interest free or low interest loan would have received a
taxable fringe benefit. It is the official rate of interest, currently 7 per
cent per annum (from 1 August 2015), which is used as the benchmark to
determine excessive benefit to the employee. If the interest applied to the
debit loan were higher than the official rate of interest, then there is no benefit
to the employee. However, where the interest applied to the debit loan is lower
than the official rate of interest, the difference would give rise to a fringe
are certain exceptions to the above. No fringe benefit will be placed on casual
loans advanced to employees however, these loans are limited to R3 000 at any
given time. Casual loans by their very nature are not loans and should not remain
outstanding for excessive periods of time. The other exception relates to loans
advanced to an employee in the pursuance of their studies. Similar to the
exemption in section 10(1)(q) where loans advanced for this purposes do not
attract fringe benefits tax.
Moving onto the second
scenario, where a debit loan exists in respect of shares being held in that
company, Section 64E(4) becomes applicable and a dividend in specie could arise. The proviso is that the creditor of such a
loan is not a company, is a resident and is connected to the lending company.
It also applies when the loan is advanced to a resident person, who is not a
company but connected to that connected person previously mentioned.
In determining whether a
dividend in specie arises, one would
have to similarly calculate the difference between the interest actually paid
and the interest that would have arisen had the official rate of interest been applied.
Where the official rate of interest is higher than the interest paid, a deemed
dividend results and dividends withholding tax of 15 per cent would be payable
to SARS on the value of the benefit. For accounting purposes, no dividend will
actually be accounted for, but because it is a dividend in specie, the dividend paid becomes the expense of the company and
will form part of its taxation expense line in the income statement. In order
to protect other shareholders of the company, the shareholders would be advised
to maintain equal shareholder loans or at least cater for this imbalanced
situation in the shareholder agreement or MOI.
It is also important to note
that if the loan was outstanding for ANY part of the year of assessment, then it
will be necessary to perform this interest calculation, even if loan was repaid
in full sometime during the year. Every time that the loan moves into debit,
there is a deemed dividend. The aggregated dividend is deemed to have been paid
on the last day of that year of assessment in terms of Section 64E(4)(c). The
calculation must be made as close to year-end as possible and although the Tax
Administration Act has not provided for a late payment penalty for dividend withholding
tax, SARS does have the ability to apply an understatement penalty. This
penalty could be as much as 200 per cent where it is a repeat case, there has
been obstructive behavior or intentional tax evasion. The VDP application is available
in these circumstances.
The above position is unlike
the previous STC regime, which was a once off event. However, if a debit loan
existed prior to 1 April 2012 and STC had been applied to the full debit loan
in terms of Section 64C(2)(g), Section 64E(4)(e) excludes these loans from the
scope of the deemed dividend rules of the dividends tax in an effort to prevent
double taxing. The drawback however, is that the exclusion does not extend to any aspect
other than the interest benefit. Therefore, the dividend that may arise when
this loan is written off would not be excluded under section 64E(4).
above circumstance must be carefully considered, expecially if the debit loan
is growing every year with undeclared distributions. The deemed dividend will
continue to grow each year and the eventual write off of this loan would also
result in a dividend in specie on the
full capital balance outstanding. This is a rather expensive option.
however, the debit loan is repaid by the shaholder, no dividends tax would be
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This article first appeared on the November/December 2015 edition on Tax Talk.