A company lending money to its directors may not be as simple a process as it may initially appear to be – not even in the case of so-called “one-man” companies. There is various requirements in the Companies Act, 71 of 2008, to be adhered to, as well as certain potential pitfalls in the Income Tax Act, 58 of 1962, that one should be aware of.
Section 45 of the Companies Act regulates the lending of money by companies to their directors. The scope of the provision also extends much further than a loan itself: it covers any form of “financial assistance” to directors, which specifically includes “lending money, guaranteeing a loan or other obligation, and securing any debt or obligation”.
The board of directors of a company must authorise the financial assistance to be provided to a director, and the board resolution to this effect must be circulated to all shareholders as well as trade unions representing employees of the company. The company’s board must further be satisfied that the financial assistance is fair and reasonable to the company, and further that the company will be solvent and liquid thereafter. They must also ensure that this is not in contravention of the company’s Memorandum of Incorporation. If in breach of any of these conditions, the directors may potentially be held personally liable for any damages.
From a tax perspective, a director of a company is by definition also an employee of that company. This means that the director may be liable for tax on a fringe benefit if a loan is extended to him or her which does not bear market-related interest rates. For purposes of the Income Tax Act, this will be the case where the loan bears interest at less than the repo rate plus 100 basis points (see paragraph 11(1) of the Seventh Schedule to the Income Tax Act). The value of any such fringe benefit will be included in the director’s gross income for tax purposes and taxed accordingly.
Fringe benefits are not the only potential tax concern for companies with loan accounts in favour of themselves against a director. Quite often directors are also shareholders in a company (which is especially the case for small and medium-sized companies). In this case, an interest free loan, or one with interest below the repo rate plus 100 basis points, will give rise to a deemed dividend in the hands of the director-shareholder. Effectively, the deemed dividend will be the interest charged too little. This amount will be calculated on an annual basis, and attract dividends tax at 15% (section 64E(4) of the Income Tax Act) which will be for the director’s account.
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)