Interest on loan accounts from directors
What type of loan accounts are there?
There are two types of loan accounts that directors can come across in business. As plain and simple as a debit and a credit loan account.
Credit balance directors loan accounts
Let’s kick it off with the first type of loan account namely a credit loan account:
When running your own business, it is easy not to use the correct mechanisms to take money out of your business, especially if you are a startup business. Typically, you put money into the business to get it off the ground, this can be done by capital that you have saved in your personal name or a loan that you received from the bank. If you loaned the money to the business, this will create a credit loan account, meaning that this is a liability in the business’s name and that the business owes you the money back. To raise interest on a credit loan is at the digression of the directors. If you decide to raise interest on your loans, it should be in the bounds of realistic interest rates. Bank loan rates can be used as a benchmark for this.
Debit balance directors loan accounts
Where it becomes tricky is where your business is up and running and you have withdrawn your capital invested in the business and you keep on drawing monies out of the business without using the right channels, suddenly the credit loan is now in a debit balance. This means that the director owes the company money. What now?
How to remedy a debit director’s loan account?
The following can be done to rectify a debit balance directors’ loan.
There are three options that can be used:
Option #1: Declare a dividend:
At year end, a dividend needs to be declared equal to the debit loan account balance and pay over dividend tax of 20% on the loan account to SARS
Option #2: Declare salaries
An additional net salary can be declared to the director. This needs to be done before year-end for it has many administrative complications and can lead to penalties and interest from SARS. Not to mention that the director has to pay over any PAYE underdeclared to SARS upon submission of their personal income tax return.
Option #3: Record interest
This option is the last resort, interest can be raised at the official interest rate of the bank. If the interest rate is not treated correctly, it can result in a deemed dividend. Some caution must be taken when making this decision as the loan can grow so large that it cannot be repaid back to the company and be eventually written off. This will trigger a major tax event in the directors’ personal name.
What can be done to keep your directors’ loan at bay?
It is important that you keep track of what is going on in your business, not only to look at your bottom line. But also, to review your balance sheet transactions each month. This will help you prevent any nasty surprises at year-end. To make this small change will help you steer your business in the right direction and will help you make decisions that will help your business grow.
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