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Tax considerations of debit loans

11 November 2015   (2 Comments)
Posted by: Author: Candice Mullins
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Author: Candice Mullins (The Tax House)

A closer look at the introduction of Dividend Withholding taxes and its impact on debit loans 

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: 

  1. 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
  2. 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 benefit.

There 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).

The 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. 

If however, the debit loan is repaid by the shaholder, no dividends tax would be payable.

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This article first appeared on the November/December 2015 edition on Tax Talk.


Mabahnu Hoosain says...
Posted 13 November 2015
Anrich A. Marais says...
Posted 12 November 2015
"the dividend paid becomes the expense of the company and will form part of its taxation expense line in the income statement." This statement seems like the dividend paid is tax deductible in terms of s 11(a)? I don't see the dividend paid being in the production of income and therefore, I don't deduct dividend tax paid. Is this correct?


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