TRUSTS

2584. Section 7C loans

FEBRUARY 2017 – ISSUE 209

In draft legislation made public in July 2016, it was proposed that low interest loans to trusts by related parties (including founders and beneficiaries) would create a tax cost for the lender equivalent to 8% of the capital value of the loan (less any interest actually paid). If that tax cost was not refunded by the trust, the tax paid would be treated as a donation subject to 20% donations tax at the top marginal tax rates.

On an interest free loan of R5 000 000 the annual cost could be R196 800 per annum. This is equivalent to an annual tax cost of 3.936% of the capital value of the loan.

After numerous representations, Treasury has agreed to amend the proposal. The interest not charged on the loan (i.e. the amount of interest below interest at the official rate of (currently) 8% per annum) would be treated as a donation on the last day of the tax year and subject to donations tax at the rate of 20% payable by the lender.

This provision, which has been promulgated into the Income Tax Act as section 7C, applies to any loan, advance or credit made directly or indirectly to a trust by a natural person, or by a company at the instance of a natural person and that company is a connected person in relation to that natural person and the natural person or company is a connected person in relation to the trust.

The annual tax cost (based on the figures in the above example) would be R80 000 (5 000 000 x 8% x 20%). Although this is far less than the previously suggested R196 800, the annual amount of R80 000, where there was previously no cost, will necessitate a substantial reconsideration of current trust structures. The amount of R80 000 is equivalent to an annual cost of 1.6% of the capital value of the loan.

Donations tax at 20% will only apply on annual donations (whether to trusts or others) in excess of the primary exemption (applicable to the donor/lender) of R100 000 per annum. This means that loans below R1 250 000 will not give rise to donations tax (8% of R1 250 000 is R100 000).

Loans to the following are excluded from the application of this new provision:

Section 7C will apply to all loans with effect from 1 March 2017 whether such loans were advanced before or after that date.

Although some might view these new proposals as a relief compared to the previous proposal, it needs to be borne in mind that the Davis Committee has made further recommendations in regard to trusts and we may not have seen the end of changes to tax legislation relating to trusts.

Even without any further changes, it must be noted that section 3(3)(d) of the Estate Duty Act, 1955 although virtually never applied to date, deems as property of the deceased for estate duty purposes, the assets of the deceased which he (briefly) had the power to control. This may include the assets of a trust where the deceased was in effective control of the trust. Whether this would be strictly applied in future or whether other trust transactions would be seen as tax avoidance in the future is obviously not clear at this stage.

Careful consideration should be given before new trust structures are created and that existing structures should be carefully examined to ensure their continued effectiveness from a tax point of view. Obviously the many other valid reasons for the use of Trusts may well override any negative tax consequences.

Crowe Horwath
Estate Duty Act: Section 3(3)(d)
ITA: Sections 7C and 31

Editorial comment
The following is an extract from the Explanatory Memorandum on the Taxation Laws Amendment Bill issued by SARS on 15 December 2016.  It explains clearly the thinking of SARS relating to loans created by the vesting of awards in a beneficiary without payment of the whole or portion of such award to such beneficiary:

“The proposed rules will apply only in respect of loans advanced or provided by a natural person or, at that person’s instance, by a connected company. An amount that is vested irrevocably by a trustee in a trust beneficiary and that is used or administered for the benefit of that beneficiary without distributing or paying it to that beneficiary will not qualify as a loan or credit provided by that beneficiary to that trust if

An amount vested by a trust in a trust beneficiary that is not distributed to that beneficiary will, however, qualify as a loan or credit provided by that beneficiary to that trust if that non-distribution results from an election exercised by that beneficiary or a request by that beneficiary that the amount not be distributed or paid over, e.g. if the beneficiary has reached the age at which a vested amount must be paid over or distributed to him or her and