INSIGHTS

On the right side of Directors’ Loan Accounts

South Africa’s hope for a resolution to its rampant unemployment problem very much lies within the SME sector of our economy. As a sector of our economy, SME’s are invaluable in many respects, not only in the unemployment discussion.

Many successful SME’s share a similar start in their journey – a savvy entrepreneur, a great business idea and plenty of personal sacrifice. As most SME’s can attest to, funding for small businesses is virtually impossible to secure until a positive trading history can be proven. This translates to the would-be successful entrepreneur ploughing his/her personal finances into the business to get it off the ground, and a consequent loan owed from the business to its founder for at least the first few years of the company’s existence.

While the business owes funds to its shareholder(s), there is no income tax event, but in reality, most owner-shareholders draw against their loan accounts over time, and it is here where risk arises as the loan account can become overdrawn i.e. becoming an asset instead of liability for the company.

Income tax implications of directors’ loan accounts

Provided the company owes the funds in question to the director concerned, there are no income tax implications for the director or for the company. It is advisable that such loans are regulated and supported by appropriate loan agreements, with interest clauses that are market related.

Interest-free loans owed by a director, that is also a shareholder in the company, are another matter and may give rise to taxation obligations. Any such loan owed to the company by such a shareholder gives rise to a deemed dividend on the last day of the financial year, with deemed dividend tax payable by the company at 20% of the value of the loan account at year end. Where the loan in question is interest-bearing at SARS official rates, these deeming provisions do not apply.

Avoiding income tax implications on debit balance directors loan accounts

Where a shareholders’ loan account is in a debit balance (owed to the company) at financial year end, the company has three choices by way of legitimately dealing with the income tax event:

Declare a dividend equal to the value of the debit balance and pay the dividend tax to SARS.
Declare additional salary or a bonus equal to the net value of the loan account. The company will include the resulting PAYE in its final EMP201 and payment to SARS, for the financial year in question.
Raise interest income on the balance of the loan account at year end at a Prime-linked rate, to avoid any deemed dividend arising on an advantageous interest rate granted.

It is important to note that the first two options above would need to be exercised prior to the end of the financial year to ensure dividends are declared prior to financial year end and/or the EMP501 for that year bears the implications of any actions taken arising from debit loan balances.

Our team of income tax professionals is accustomed to dealing with situations like directors’ loan accounts and is well placed to offer sound professional advice on compliance matters with SARS. If you would like to consult one of our income tax professionals for your business or for your personal taxation matters, reach out to us by visiting the Income Tax page on our website.