Interest on a Director's loan account
South Africa's solution to high unemployment lies in the small and medium-sized enterprises (SMEs) of our economy. SME's are generally the largest part of an economy, so it is clear to see get this right and you can solve many economic issues.
SME's and small business owners all have one thing in common and that is loads of sacrifice, dedication and personal investment in a dream and driving that to success.
The biggest stumbling block for small businesses is gaining access to funding especially when there is no proven track record on a balance sheet, profit and loss statements, equity, cash flow and management statements, all of which are required by institutions who lend money.
Often small business owners have to personally carry costs and make a plan in order to build the business and this can come at a cost. There are also situations where the owner ends up lending money from the business because they are not paying a high enough salary to cover their personal living expenses.
There is no immediate corporations tax consequence if the business owes the director money via a loan account however interest at market related interest rates is advised if they are more favourable versus a deemed dividend.
The major risk with loan accounts is if they become well overdrawn. These situations result in an asset for the business and then the dividend or interest obligation kicks in.
Frequently asked questions
Can a director loan money to his company South Africa?
If a director owes money to the company, it is considered as a dividend on the last day of the year. The company must pay 20% tax on the value of the loan at the end of the year.
Do you pay interest on a director loan account?
Company directors may charge the company interest on the loan account. The interest rate applied should be the prevailing official rate. It is important that interest should also be linked to risk factors attached to the loan.
Is the interest on a directors' loan tax deductible for a company?
Interest on a director's loan is only deductible so far as it was incurred in the production of income. In plain English, those expenses must relate to the trading activity. If not, they will be viewed as personal expenditure. Tax is payable on those expenses that are not in the production of income. This comes in through the interest provision in a tax year and the resulting assessment and tax return.
What are the Income tax implications of a director loan account
If the company owes money to the director, there are no tax issues for the director or the company. It is recommended to regulate and support these loans with appropriate loan agreements and market-related interest clauses. Prevailing rates of interest are advised until the loan is repaid.
Loan accounts where the director owes the company do raise tax consequences in the form of a deemed dividend as at the end of the financial year and the reporting that it affects. There would be various factors to take into account when faced with a deemed dividend for example: the commercial interest rate versus the dividend rate as well as the individual's personal income tax rate The tax charge on a deemed dividend is 20%.
How can you avoid interest on a director loan account
A company has three choices if the director owes the company money via a loan account.
Tax considerations are:
- Declare a dividend on the loan account balance. This results in dividends tax.
- Reduce the loan account by means of paying a higher salary to the director. This results in employees' tax.
- Charge interest on the director loan account at the prevailing official rate.
It is important for the company to do tax planning and to weigh up the various options and to ensure this is implemented timeously to avoid missing deadlines paying more tax than is necessary.
Dividends should be declared before year end to ensure the amounts are not accounted for on interest calculations.
Do you need a quote for our Accounting or Tax services?
Contact our team via any of the following channels to get a proposal for your accounting and tax services:
Subscribe to our newsletters.
Disclaimer:
The views or opinions expressed on this site are solely those of the original authors and other contributors.
The material and information contained on this website is for general information purposes only.
This information is for general purposes only. Don't use this information for making business, legal and tax decisions without consulting a professional.
We do not make any express or implied representation, as to the completeness or accuracy of the information published.
Tax law changes regularly, and any tax information on this site might be outdated.
We are not responsible for any other websites that you may access through links on our website.
ZPA accepts no liability for any loss or damage arising from the use of any material on this site.
