By: Graeme Palmer, a Director in the Commercial Department of Garlicke & Bousfield Inc
It is common for a company to lend funds to its shareholders. These advances could be made for a variety of reasons and are often referred to as debit loans. However, if a loan is made to a shareholder at a low interest rate or interest free it may trigger dividends tax.
Dividends Tax applies at a rate of 15% on dividends paid on or after 1 April 2012. But it is not only a cash dividend or the distribution of assets in specie that triggers the tax, there are provisions in the Income Tax Act, 1962 (the Act) which deem certain low interest or interest free debit loans to be dividends.
Section 64E(4) of the Act applies where any amount is owing to a company, by virtue of any share held in that company, by a person that is –
- not a company;
- a resident; and
- either a connected person to the company or a connected person to that person.
If all of these elements are present the company is deemed to have paid a dividend in specie.
The dividend amount will be equal to the greater of the market related interest in respect of the debt, less the amount of interest payable to the company in respect of the debt for that year of assessment, or nil. Therefore, the dividend is determined by applying an interest rate to the debit balance on the loan account during the year. The interest rate that is used is the difference between the ‘market-related interest’ (i.e. the “official interest” as defined in the 7th Schedule of the Act, and currently 7.75%) and the actual interest rate charged on the loan.
The dividend will be deemed to have been paid on the last day of the year of assessment. As the dividend is deemed to consist of a distribution of an asset in specie, it is the company, and not the shareholder that becomes liable for dividends tax under section 64EA(b).
For example, Company ABC (Pty) Ltd advances a loan of R1 million on 1 March 2016 to shareholder X at an interest rate of 4%. In year one the amount of the dividend deemed to have been paid will be R37 500 [R1 million x 3.75% (7.75% – 4%)]. The dividends tax payable in year one by ABC (Pty) Ltd will be R5 625 (R37 500 x 15%).
NOTE: This information should not be regarded as legal advice and is merely provided for information purposes on various aspects of tax law.