In our previous article related to this topic, we highlighted proposed new tax laws that would apply to low or interest free loans made to a trust. Those proposed laws were subject to public comment and, as a result, National Treasury has made substantial revisions to the proposals to be introduced as Section 7C of the Income Tax Act. The revised laws have been published in the Taxation Laws Amendment Bill of 2016. The Bill is currently with Parliament but has not yet been formally signed into legislation.
In this article we shall discuss the application of the revised laws that are set to come into effect.
Analysis of Section 7C
- The section will apply to any loan, advance or credit that-
- a natural person;
- or at the instance of that person, a company in relation to which that person is a connected person by virtue of holding at least 20% of the shares or voting rights in that company, directly or indirectly provides to a trust where that person is a connected person to the trust.
- Where the qualifying loan does not bear interest, an amount of interest calculated at the official rate of interest (currently 8%) must be treated as a donation made to the trust by that natural person.
- Where the qualifying loan does bear interest, but at a rate lower than the official rate (currently 8%), then the difference or shortfall in interest must be treated as a donation made to the trust by that natural person.
- The amount that is to be treated as a donation made to the trust is deemed to occur on the last day of the year of assessment of the trust.
- Compared to the first round of proposed laws where the amount of interest as calculated above was to be included as the income of the natural person, the amount will now be treated as a donation and subject to donations tax at the rate of 20% of the amount that is treated as a donation made to the trust.
- There are certain specific exclusions from the application of these new provisions, namely:
- A loan that is made to an approved Public Benefit Organisation;
- A loan provided to a trust in return for a vested interest in the income and the assets of the trust, subject to certain additional requirements;
- A loan that is made to a special trust established for the benefit of a person with a disability;
- A loan made to a trust where the trust used the funds to acquire a property that was used throughout the year of assessment as the primary residence of the lender or his or her spouse;
- A loan that is subject to the transfer pricing provisions in section 31 of the Income Tax Act. This would mean that a loan to an offshore trust would not be subject to section 7C if it is already subject to the transfer pricing provisions;
- A loan to a trust that would have qualified as a Sharia compliant financing arrangement; or
- A loan that is subject to the provisions of section 64E(4), namely loans that are subject to the deemed dividend provisions.
- These new provisions are set to come into operation from 1 March 2017, and will apply in respect of any amounts owed by a trust in respect of a loan, advance or credit provided to the trust before, on or after that date.
What does this mean?
Where a trust has been funded by means of an interest free or low interest loan, the amount of interest not charged will be treated as a donation made by the natural person. This would mean that the natural person is exposed to a donations tax liability. A natural person is however entitled to an annual donations tax exclusion, that being on the first R100 000 of donations made. As a result, assuming that the natural person has made no other donations, there would be no donations tax liability on a loan up to R1 250 000. This is calculated on the basis that interest on a loan of that value at 8% would equate to R100 000, thus utilising the annual exclusion.
Plans to manage your exposure
There is unfortunately no one solution that can manage all potential exposures to these new rules. However, there are some considerations that may be appropriate, such as:
- There could be a repayment by the trust of the loan. This does however come with other repercussions, for example it may give rise to a Capital Gains Tax liability if assets need to be realised to fund the repayment of the loan. In addition, the natural person would need to assess the impact to his or her personal financial plan due to the change in the nature of the asset.
- Consider donating a portion of the loan between spouses to reduce one person’s exposure.
- Where in addition to the loan payable, a trust has a loan receivable, that loan receivable could be ceded to the loan creditor so as to reduce the liability due by the trust.
- Consider bringing in the application of section 64E(4) by having the natural person cede his or her loan account entitlement to a company in which the trust holds ordinary shares. This will attract section 64E(4) and reduce the effective rate of tax on the transaction, in comparison to the natural person, that will be imposed upon the company.
The first consideration should be for a person to determine whether they will be negatively impacted by these new laws and, if so, what is the factual cost of such impact. Where the impact warrants further action, careful consideration to different plans should be given, bearing in mind the purpose of the trust as well as the individual’s personal estate plan. Timing is also of importance in instituting any plans, bearing in the mind the effective date. Consideration will also need to be given to the potential of further changes in the upcoming 2017 Budget Speech where there could be revisions made to the Estate Duty provisions as well as increases in the maximum marginal rates of tax.
We recommend that you approach us should you require further guidance in the application of these new laws.
Tax and Trust Director, Johannesburg