Monthly Archives: June 2017

Interest free loans to directors

It is very often the case that a company extends an interest free or low interest loan to a director. This manifests either as a true incentive or benefit to that director (mostly the case in larger corporate environments) or in a small business environment in lieu of salaries paid. The latter is especially the case for example where a spouse or family trust would hold the shares in the company running the family business, but which business is conducted through the efforts of the individual to whom a loan is granted from time to time.

In terms of the Seventh Schedule to the Income Tax Act[1] a director of a company is also considered an “employee”.[2] This is significant, since directors can therefore also be bound by the fringe benefit tax regime applicable to employees generally.

Paragraph (i) of the definition of “gross income” in the Income Tax Act[3] specifically includes as an amount subject to income tax “the cash equivalent, as determined under the provisions of the Seventh Schedule, of the value during the year of assessment of any benefit … granted in respect of employment or to the holder of any office…”

Clearly, benefits received by a director of a company would therefore rank for taxation in terms of this provision. The question remains therefore whether loans provided to such directors by the companies where they serve in this capacity would amount to such a taxable benefit, and further how such benefit should be quantified.

Paragraph 2(f) of the Seventh Schedule is unequivocal in its approach that a taxable fringe benefit exists where “… a debt … has been incurred by the employee [read director], whether in favour of the employer or in favour of any other person by arrangement with the employer or any associated institution in relation to the employer, and either-

(i)            no interest is payable by the employee in respect of such debt; or

(ii)           interest is payable by the employee in respect thereof at a rate of lower than the official rate                of interest…”

Paragraph 11 in turn seeks to quantify the amount of the taxable fringe benefit to be included in the gross income of the director. Essentially, the taxable fringe benefit would be equal to so much of interest that would have been payable on the loan at the prime interest rate less 2.5%, less any interest actually paid on the loan. The benefit therefore does not only arise on interest-free loans, but also on loans carrying interest at less than the prescribed interest rate.

It is necessary to note that a fringe benefit otherwise arising will not be a taxable benefit if the loan amount is less than R3,000, or if it is provided to the director to further his/her studies.

[1] 58 of 1962
[2] Paragraph 1 of the Seventh Schedule, paragraph (g) of the definition of “employee”
[3] See section 1

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)

Interest free loans cross border

A consideration of the tax consequences of interest free loans will be incomplete if not also considered in the context of interest free debt funding being provided cross-border. Typically, when “cheap debt” is encountered it is in the form of low interest or interest free loans being provided to related parties (or “connected persons” as defined) due to the non-commercial nature of such an arrangement. This is especially the case for the lender, who could typically receive far greater returns on investment if utilising excess cash in another manner. However, due to group efficiencies, it may be preferable for one group company to provide low interest or interest free financing to a fellow group company, especially if this also has the potential to unlock certain tax benefits.

One such manner in which a corporate group may save on its ultimate tax bill is to ensure that funding is provided by a company situated in a low tax jurisdiction, such as Mauritius for example (which levies a corporate tax rate of effectively 3%). Were the Mauritius company to lend cash to a South African group company, the group would prefer it to do so at a very high rate. This would ensure that the South African company is able to deduct interest in a corporate tax environment where it would create a deduction of effectively 28%, whereas the tax cost would only be 3% in Mauritius.

Where the South African company however is in the position that it sits on the group’s cash resources, it would want to lend money to the Mauritius company at as low rate as possible. Interest, to the extent charged, will now only be deductible at an effective 3% in Mauritius (where the borrower is situated), whereas interest received will be taxed at 28% in South Africa. Such a loan would therefore be most tax efficiently structured as an interest free loan.

The transfer pricing regime, contained in section 31 of the Income Tax Act,[1] seeks to legislate against this tax avoidance behaviour. The provision, which covers all cross border transactions entered into by connected persons, but specifically also cross border debt financing, determines that in such instances “… the taxable income or tax payable by any person contemplated … that derives a tax benefit … must be calculated as if that transaction, operation, scheme, agreement or understanding had been entered into on the terms and conditions that would have existed had those persons been independent persons dealing at arm’s length.”

In other words, the tax consequences of cross border debt funding with connected persons will be calculated as though arm’s length interest rates would have been attached thereto. Therefore, even though the loan extended by the South African company above to the Mauritian company would have been interest free in terms of the financing agreement, the South African company will still be taxed in South Africa as though it has received interest on arm’s length terms. The same is true for the exaggerated rates that may have been charged had the South African company been the lender: SARS would adjust these rates downward to ensure that the South African company does not claim inflated interest costs.

Using interest free or low interest loans as a tool to increase tax efficiency, especially in a cross border context, much be approached with circumspection. It may very often amount to a blunt and clumsy tax planning tool at best.

[1] 58 of 1962

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)

Interest free loans with companies

The latest annual nation budget presented in Parliament proposed the dividends tax rate to be increased with almost immediate effect from 15% to 20%. The increased rate brings into renewed focus what anti-avoidance measures exist in the Income Tax Act[1] that seeks to ensure that the dividends tax is not avoided.

Most commonly, the dividends tax is levied on dividends paid by a company to individuals or trusts that are shareholders of that company. To the extent that the shareholder is a South African tax resident company, no dividends tax is levied on payments to such shareholders.[2] In other words, non-corporate shareholders (such as trusts or individuals) may want to structure their affairs in such a manner so as to avoid the dividends tax being levied, yet still have access to the cash and profit reserves contained in the company for their own use.

Getting access to these funds by way of a dividend declaration will give rise to such dividends being taxed (now) at 20%. An alternative scenario would be for the shareholder to rather borrow the cash from the company on interest free loan account. In this manner factually no dividend would be declared (and which would suffer dividends tax), no interest accrues to the company on the loan account created (and which would have been taxable in the company) and most importantly, the shareholder is able to access the cash of the company commercially. Moreover, since the shareholder is in a controlling position in relation to the company, it can ensure that the company will in future never call upon the loan to be repaid.

Treasury has for long been aware of the use of interest free loans to shareholders (or “connected persons”)[3] as a means first to avoid the erstwhile STC, and now the dividends tax. There exists anti-avoidance legislation; in place exactly to ensure that shareholders do not extract a company’s resources in the guise of something else (such as an interest free loan account) without incurring some tax cost as a result.

Section 64E(4) of the Income Tax Act provides that any loan provided by a company to a non-company tax resident that is:

  1. a connected person in relation to that company; or
  2. a connected person of the above person

“… will be deemed to have paid a dividend if that debt arises by virtue of any share held in that company by a person contemplated in subparagraph (i).” (own emphasis)

The amount of such a deemed dividend (that will be subject to dividends tax) is considered to be effectively equal to the amount of interest that would have been charged at prime less 2.5%, less so much of interest that has been actually charged on the loan account.

It is important to also appreciate that the interest free loan capital is not subject to tax, but which would also have amounted to a once-off tax only. By taxing the interest component not charged, the very real possibility exists for the deemed dividend to arise annually, and for as long as the loan remains in place on an interest free basis.

[1] 58 of 1962
[2] Section 64F(1)(a)
[3] Defined in section 1 of the Income Tax Act

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)

 

Newtons went “back to school”

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Newtons went “Back to School” for Youth Day this year and had the privilege of having Sheri Brynard as our guest speaker. Sheri is a world renowned speaker and international ambassador for all people with Down syndrome.

She is the only person with Down syndrome (normal Trisomy 21) who has a tertiary teacher’s diploma (in Educare), without any amendments had been made to the course (or special assistance), in the world. What makes this an even greater achievement is the fact that her lectures and her study material was only provided in English, her second language.

She is currently an assistant teacher in a Pre-primary school for learners with special needs.

Shéri tries to change negative perceptions about people with Down syndrome and she is an activist to give all people with Down syndrome the same opportunities they would have had, if they were fully abled.

She truly believes that all people have the ability to choose to make the best of their circumstances and she is the living example of that.