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Interest-free loan to a shareholder: possible deemed dividend

Monday, 10 November 2014   (0 Comments)
Posted by: Author: SAIT Technical
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Author: SAIT Technical

Q: I have a question regarding a deemed dividend. A company’s balance sheet reflects a debit loan to an individual shareholder in the February 2014 financial statements. There is no interest charged on the loan. It is therefore my understanding that the interest that should have been earned on this loan (at the official rate) is a deemed dividend in terms of Section 64E.

However the company has an assessed loss and no reserves and only R100 contributed tax capital. I understand that in terms of the old STC rules there could be no deemed dividend but I am questioning the scenario regarding Dividend Withholding Tax.

Please advise if my reasoning below is correct:

In terms of the definition of dividends as per the Income Tax Act, any amount transferred or applied, to the extent that it results in a reduction of the company’s contributed tax capital, is excluded from the definition of dividend.

The company’s equity account as per the annual financial statements reflects an accumulated loss, contributed tax capital is R100 and by implying that the loan to the shareholder will be a dividend, such dividend would reduce the contributed tax capital of the company. The amount is therefore excluded from the definition of dividends and no dividends tax is payable. If my reasoning is not correct, could you please advise if there is any circumstance under which a non-interest bearing loan account to an individual shareholder will not be subject to Section 64E?

A: Our guidance assumes that the shareholder is a connected person in relation to the company and that the debt arose by virtue of any share held in that company by the shareholder.  

The amount of the dividend that is deemed to have been paid in terms of section 64E(4) is the greater of the market-related interest in respect of that debt, less the amount of interest that is payable to that company in respect of that debt for that year of assessment; or nil.  It is not 100%, as you indicate, "the interest that should have been earned on this loan (at the official rate)” that is deemed a dividend.  It is true that the ‘market-related interest’, in relation to any debt owed to a company means the amount of interest that would be payable to that company on the amount owing to that company in respect of that debt for a period during a year of assessment if the debt had been owed for that period at the official rate of interest as defined in paragraph (1) of the Seventh Schedule.  

The second point is that section 64E(4) deems a dividend to be paid under the circumstances listed in the section.  It does not deem the amount to be "transferred or applied by” the company for the benefit or on behalf of any person in respect of any share in that company by way of a distribution made by the company.  In fact, there is no actual distribution by the company.  

In addition, whilst not a tax related issue, we submit that the directors of the company, in approving the loan, had to apply the solvency test.  The fact that there is a loss will therefore not mean that section 64E(4) does not apply.  

Disclaimer: Nothing in this query and answer should be construed as constituting tax advice or a tax opinion. An expert should be consulted for advice based on the facts and circumstances of each transaction/case. Even though great care has been taken to ensure the accuracy of the answer, SAIT do not accept any responsibility for consequences of decisions taken based on this query and answer. It remains your own responsibility to consult the relevant primary resources when taking a decision.



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