Dividends interest on loan

Dividends interest on loan

• 04 December 2023
• Accounting
• The Tax Faculty Tax Specialist

This FAQ article is based on tax law for the year ending 29 February 2024.

1. The Problem / Facts

Is a debit loan balance regarded as a deemed dividend, or is only the interest-free portion considered a dividend?

2. Applicable Law 

Income Tax Act Section 64E(4)

3. Application of the Law to the Facts

Where a debit loan exists and the interest charge on the outstanding balance is lower than the official interest rate, the difference will give rise to a dividend in specie. The dividend is deemed to have been paid on the last day of the year of assessment and the company will be liable for the dividends tax. 

The capital is not deemed a dividend and the interest will accrue posing a tax risk should the loan and accrued interest be written off some time in the future.

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FAQs

1. Is it better to receive dividends or interest from a company loan account in South Africa?

It depends on your tax objectives. Dividends are generally taxed at 20% withholding tax, while interest is taxed at your marginal income tax rate, which can be higher. However, interest is tax-deductible for the company, while dividends are not.

2. How is interest on a shareholder loan taxed in South Africa?

Interest earned on a shareholder loan is included in your gross income and taxed at your applicable income tax rate. For individuals, this can be up to 45%, while for trusts, it may be higher.

3. Are dividends from a private company taxable for South African residents?

Yes. Dividends from a private company are subject to Dividends Tax at 20%, which is withheld by the company before payment to the shareholder. However, no additional tax is payable by the individual receiving the dividend.

4. Can a company deduct interest paid to a shareholder as a business expense?

Yes. If the interest paid is market-related and the loan was used to generate income, the company can deduct the interest expense, reducing its taxable income. However, SARS may disallow excessive or non-arm’s-length interest rates.

5. When is it more tax-efficient to earn interest rather than dividends?

Interest may be more tax-efficient if the recipient has unused interest exemptions (e.g., R23,800 for individuals under 65) or if they fall into a low-income tax bracket, making their effective tax rate on interest lower than 20%.

6. Can a shareholder charge interest on a loan to the company?

Yes, shareholders can charge interest on loans to the company, provided it is at a reasonable, market-related rate. Charging interest can be a way to receive income, but it will be taxed differently than dividends.

7. What are the risks of paying interest instead of dividends?

Interest is not subject to the same tax relief as dividends. It increases the taxable income of the recipient and may trigger section 31 transfer pricing rules if not set at an arm’s-length rate. Also, SARS may scrutinise excessive interest payments.

8. Can I choose between receiving interest or dividends from my company?

Yes, but the choice must be legally and commercially justifiable. For example, you can structure your compensation through either shareholder loans (with interest) or equity (with dividends), depending on your tax planning goals and SARS compliance.

9. How can interest-free or low-interest loans affect tax liability?

If a loan is interest-free or below the SARS official rate of interest, a deemed interest benefit may arise, which can be taxed as a fringe benefit or trigger donations tax, especially in connected-party transactions.

10. How do I declare interest or dividend income on my South African tax return?

You must declare interest under the Investment Income section and dividends under the Local Dividends section of your ITR12 tax return. SARS may already have this information via third-party data, but you should always double-check and declare accurately.

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