Director's Loan/ Current Accounts

[PCAdeJ]

Good day everyone,

If a Director’s Current Account is in credit, what is a reasonable interest rate for him to charge the company, if any?

The reason I ask is because I want to buy into a Company however my partner/ the other 50% Director has a R4 700 000 loan account in his favor. Up until this point he has not charged any interest on the capital by now with the restructuring he is considering it.

What are the implications of this for the company's profitability? I mean would it not be fair to say that the interest of the loan account is paid out in the form of Dividends and that the capital appreciation of the company's assets will/should cover this interest? Im just trying to clarify as I want to be as fair as possible.


Regards,
PCAdeJ

[CLIVE-TRIANGLE]

I suppose anything up to prime is reasonable. But, thats R400k per year!

I would imagine that the reason he is now considering it is because you might now be a 50% shareholder and get the benefit of the loan by virtue of your equity. I don't mean 50% of the loan, but the company benefits from it and by default so would you.

Dividends are a share of profit, as you know. But the profit is generated from working capital, inter alia, and I guess therein lies his change of mind. Whether or not this is fair and reasonable depends on the gearing of the company, and the price of the shares and anticipated ROI.

Perhaps the best way to consider the fairness / reasonableness is to, for a moment, pretend the R4.7m loan was from a financial institution and then consider the impact on the company's profitability and more importantly, what you are paying for the shares. This is appropriate because the loan is decidedly distinct from the shares, and therefore dividends should not be a factor in your consideration.

[PCAdeJ]

Thank you,

That was a very succinct and intelligent response! And it echos my sentiments, however I was hoping that was not the case as 400k will materially affect the profitability for the first few years but I guess Fair-is-Fair...

Regards,
PCAdeJ

[Sky]

Do you think he is using your investment as his cash out?

I would question the case only if direct implications to cash flow would materialise.

Ohterwise Clive is right on the spot - it is an earned benefit he owns.

If the rolls were reversed what would you have done?

[PCAdeJ]

Do you think he is using your investment as his cash out?

Hi,

No his business integrity is above reproach, haha he wouldn't just stick me with running the company and ride out the interest..

Ive just actually had a brief discussion with him and he said he'll keep the interest low but we haven't formalized a number yet?

So guys any suggestions/ negotiating points?


thanks

[Justloadit]

If I am not mistaken, there is something with respect to SARS, and interest rate values, which may have implications to both the company and the owner of the loan account. Remember that SARS is looking for any form of income to tax, and if interest is not being charged, then it means that the company is benefiting by not having to pay the interest.

I am sure one of our more learned friends will be able to shed further light on this.

[Dave A]

If I am not mistaken, there is something with respect to SARS, and interest rate values, which may have implications to both the company and the owner of the loan account.

For the 2013 financial year I was required to raise interest on inter-company loan accounts, but not on my directors loan account where the company owes me money.

On the "SARS is hungry for taxes" angle - The fact that SARS required this actually had me chuckling as the interest expense was claimable on the debtor company side, but formed part of exempt income for the recipient company. SARS had shot itself in the foot on this one

As a result, my ears pricked up about a month ago on news that SARS is considering excluding interest received from connected parties from exempt income...
There certainly seems to be change in the air on the issue.

So I think Justloadit raises a valid consideration - within the next year or so the decision might be taken out of your/your future partner's hands.

[CLIVE-TRIANGLE]

I sincerely doubt that shareholder loans to the company will be obliged to bear interest.

A bigger risk is the origin of the loan. If the loan arose as a working capital loan, and it bears interest, all is usually fine.

On the other hand, I have seen many loans that arose out of dividend declarations. Under those circumstances the deductability of the interest will always be in question. Material interest deductions, such as the one envisaged here, are ALWAYS scrutinized by SARS and the golden rule is that the deductability of any amount is decided by the extent to which it was incurred in the production of income.

[Phil Cooper]

SARS are starting to look at loans - and come back to you saying R X MUST be declared as a dividend, and you have to pay them R Y as dividend tax.....