In many South African private companies, the shareholders’ loan account is the largest liability on the balance sheet. Owners fund start-up costs, cover cash shortfalls and pay for equipment out of their own pockets, and the bookkeeper records it all as a loan. Often there is no written agreement, no interest and no repayment date.
That informality usually goes unnoticed until something changes. A bank asks for the loan to be subordinated before it extends a facility. An investor wants to know whether the shareholders can demand repayment the day after the money comes in. SARS queries a write-off. Or a shareholder dies, and the executor wants the loan repaid to the estate.
This article explains why shareholder loans deserve proper documentation, the main tax rules that apply to them, and how subordination works.
Loan or equity?
A shareholder can fund a company in two broad ways: by subscribing for shares or by lending money. Shares give ownership and a right to dividends, but share capital is difficult to return. A loan gives the shareholder a claim against the company that ranks ahead of shareholders (but, unless secured, alongside other ordinary creditors) if the company fails, and it can be repaid without the formalities of a share buy-back or capital reduction.
That flexibility is why loans are popular. But it only works if the loan is properly recorded. Without a written agreement, disputes arise about whether an amount was a loan, a capital contribution or a gift, when it is repayable and whether interest is payable. Our article on debt or equity funding sets out the wider trade-offs.
What a shareholder loan agreement should cover
A short written agreement, approved by the board, avoids most problems. It should deal with:
- the amount and how further advances are recorded, especially where the account fluctuates;
- interest, including the rate, when it accrues and when it is paid, or a clear statement that the loan is interest-free;
- repayment terms, such as a fixed date, instalments, or repayment only on notice;
- subordination, if the loan must rank behind other creditors (see below);
- security, if any, and how it ranks against bank security;
- conversion rights, if the loan may be converted into shares; and
- what happens on death, exit or sale, including whether a buyer of the shares must also take over the loan account.
Repayment terms matter for prescription. Under the Prescription Act 68 of 1969, an ordinary debt prescribes after three years from when it becomes due. A loan that is repayable on demand may be treated as due from the date it is advanced, unless the agreement clearly provides otherwise, so an undocumented loan can expose the lender to a prescription defence. An annual written acknowledgement of the balance by the company, or a clause making the loan due only after a notice period, helps manage this risk. We explain the rules in more detail in our article on prescription.
Subordination: why banks and auditors ask for it
Under the Companies Act 71 of 2008, a company is solvent for the purposes of the solvency and liquidity test in section 4 if its assets, fairly valued, equal or exceed its liabilities. A large shareholder loan can push liabilities above assets, so on paper the company looks technically insolvent.
A subordination agreement addresses this. The shareholder agrees that the loan will rank behind the claims of other creditors, and will not be repaid until the company’s assets again exceed its liabilities (often measured without counting the subordinated loan). Auditors and independent reviewers commonly rely on such an agreement before signing off on going-concern assumptions, and lenders frequently require one as a condition of a facility.
Points to check in a subordination agreement include:
- whether it covers the whole loan or only the amount needed to restore solvency;
- whether interest may still be paid while the subordination is in force;
- whether it is in favour of all creditors or only a specific bank; and
- when and how it falls away.
Directors should remember that subordination is a ranking arrangement, not a cure for an unprofitable business. Directors still need to consider whether the company is trading recklessly or is financially distressed for the purposes of business rescue.
Tax issues to consider
The tax treatment of shareholder loans can be complex, and the right answer depends on the facts. The main rules to be aware of under the Income Tax Act 58 of 1962 are:
- Interest. Interest paid by the company is generally deductible if the loan funds income-earning activities, and is taxable in the hands of the lender. Where the lender is in a controlling relationship with the company and is not subject to tax on the interest (for example, certain non-resident or exempt lenders), section 23M may limit the deduction.
- Interest-free loans to a company. Interest-free funding by an individual shareholder is generally permitted. However, where a trust connected to the lender holds 20% or more of the company’s shares, section 7C can treat the forgone interest as a donation, subject to donations tax. This anti-avoidance rule is often overlooked in family structures.
- Loans by the company to a shareholder. Where a company lends to a resident individual shareholder (or a connected person) at less than the official rate of interest, section 64E(4) can treat the benefit as a dividend in specie, subject to dividends tax.
- Writing off or reducing the loan. If the shareholder forgives the loan, the debt reduction rules in section 19 and paragraph 12A of the Eighth Schedule may reduce the company’s tax allowances or base cost, or trigger a recoupment. Forgiveness by an individual may also be a donation.
- Converting the loan into shares. Capitalising a loan by issuing shares has its own rules, including specific provisions for conversions within groups of companies. The structure should be checked before it is implemented.
- Cross-border loans. Loans from non-resident shareholders raise transfer pricing questions under section 31 and need exchange control approval through an authorised dealer.
Loans from the company to its shareholders
The reverse situation is common too: a shareholder draws money from the company and the loan account goes into debit. Apart from the tax consequences above, the board must comply with section 45 of the Companies Act if the shareholder is also a director or a related person. That requires authority under the Memorandum of Incorporation, a special resolution of shareholders and a board finding that the company will satisfy the solvency and liquidity test.
A practical checklist
- Reconcile each shareholder’s loan account and agree the balance in writing.
- Put a written loan agreement in place, approved by board resolution.
- Decide on interest, repayment and conversion terms with your tax adviser.
- Check whether any bank facility, lease or investment agreement restricts repayment.
- If the company’s liabilities exceed its assets, consider a properly drafted subordination agreement.
- Review any debit loan accounts for section 45 and section 64E(4) compliance.
- Align the loan with your shareholders’ agreement, buy-and-sell arrangements and each shareholder’s will.
- Diarise an annual review and written acknowledgement of each balance.
How O’Reilly Law can help
We draft shareholder loan agreements, subordination agreements and conversion documents, prepare the board and shareholder resolutions needed under the Companies Act, and review loan accounts as part of funding rounds, sales and restructurings. We work with your accountant and tax adviser so that the legal and tax treatment are aligned.
Contact us to put your shareholder loans on a proper footing.
Related reading: Debt or equity? Funding options for growing businesses · Holding company structures: benefits, risks and tax
This article is general information and not legal or tax advice. Correct as at November 2026.