When it comes to business loan accounts, both directors of the company as well as shareholders must be aware of the implications such loan accounts may have on the business.
However, there is an abundance of small to medium enterprises in South Africa which are mostly owned and directed by as little as one or two people.
This means that the director is also the shareholder of the company and the start-up is often funded by individuals who invest in the company and receive company shares in exchange.
A percentage of the funding supplied by the directors to the company can be recorded as a loan. This is what is referred to when talking about business loan accounts.
Consequently, there exists a credit balance recorded on the members loan account balance sheet which is owed to the director(s).
There may come a time when a director needs to use capital from the business bank account in order to pay for a personal expense.
This use of capital is effectively seen as a "repaying the director" and decreasing the credit owed to him or her.
Loan transactions between the company and its directors should technically be regulated and managed according to the agreements stipulated in the Companies Act.
However, in the case of the director also being the shareholder of the company, there is no body of directors in place to make executive decisions related to business conduct.
Furthermore, in such cases, there is less risk of poor conduct and reckless management by the directors, because they face a much greater loss should they make loans beyond their means.
However, should directors not keep up to date with what is recorded against their business loan accounts, these accounts may go over into a debit.
A loan account in debit means that the director now owes the company money and no longer the other way around.
From a tax point of view, the implications can be severe. According the Income Tax Act, “a debit loan will be treated as a deemed dividend paid to the director on the last day of the tax year.”
Therefore, the company will be required to pay tax at a flat rate of 20%.
Should the directors loan account become a debit, the director has three options:
The director has the option to declare the amount owing to the company as an extra salary paid to him or her. This declaration must take place before the end of the tax year.
If the salary is declared only after the end of the tax year, related penalties and interests will be applicable.
By declaring the amount as an extra salary before the end of the tax year, the director’s debt to the loan account will be cleared.
The director can choose to declare a dividend which is equal to the amount owed and the company will then pay the divided tax to SARS.
In this case, the amount owed by the director will also be cleared at the end of the year.
The company’s official financial statements should be prepared within 6 months after financial year-end. However, by this time, the EMP501 (report of all staff earnings) should have already been submitted and dividends for the closed financial year can no longer be declared.
In this case, the company may record interest at the rate which is currently linked to the official interest rate.
The difference between the official interest rate and the lower interest rate will be deemed as a dividend.
This should be a last resort for any director who owes the company. If not properly managed, a director’s loan account will keep growing and eventually the director will be unable to repay the full amount.
Large loans that are written off have massive once-off tax effects on the company.
An important thing to remember is that a director’s tax bracket must always be taken into consideration when deciding which one of the above options will have the lowest possible tax implication.
As an entrepreneur and small to medium business owner, it’s quite safe to say that the directors of these companies are by nature proactive, which is key to avoid getting into any unwanted tax-paying situations.
A monthly review of loan accounts can surely help directors stay on track.
However, if directors have a stable cash flow, there is the option of rather drawing a lump sum from the company at the start of the year and then transferring this amount to their personal account.
The capital in the account can then be used to pay for personal expenses and to earn interest as a private individual or natural person.
A natural person has the capacity to earn interest which will be tax free – as opposed to the company paying tax in its capacity as a business.
Then, at the end of the financial year, the director can repay the loan owed to the company which effectively clears the original loan amount at the start of the new tax year.
Business loan accounts can be useful and enjoyed by directors who have managed them properly throughout the year. There is no reason for these loan accounts to result in unmanageable debt.
For advice on managing small business loan accounts or for more information on our debt collection services, contact us.
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