On 1 March 2017 the Taxation Laws Amendment Act, 16 of 2016 came into effect, introducing section 7C into the Income Tax Act, 58 of 1962. This new provision will have an impact on low interest or interest-free loans to trusts.
Previously, estate planners transferred their wealth by making use of their trusts by either:
- donating assets to the trust with donations tax becoming payable;
- selling assets to the trust on loan account, the loan being subject to interest below market rates or without any interest being charged at all; or
- by advancing interest free loans to trusts to enable the trusts to acquire assets or to retain such advances without any interest being payable.
No donations tax was payable in the second example, as the transaction was a sale and not a donation. Furthermore, income tax was also not paid by the estate planner, as no interest or below market interest rate was payable. With advancing loans to trusts, as per number 3 above, no donations tax was triggered and once again income tax was also avoided due to no interest or low interest being charged. In some cases the loan capital of the advance would also at a later stage be waived, avoiding estate duty on the lender’s side.
As result of the reduction on the tax base created by aforementioned arrangements, Section 7C was introduced as an anti-avoidance measure to limit the possibilities of transferring wealth to trusts without being subject to tax.
Which loans will be affected?
All interest-free loans or loans with interest below market rates made to trusts directly or indirectly by:
- a natural person, or
- a company that is a connected person in relation to that natural person (this means a company in which such natural person, individually or together with a connected person/persons, holds an interest of at least 20%).
This will apply to all loans, including loans currently in existence, that meet the criteria as mentioned above and mean to include loans or credit provided directly to a trust as well as loans and credit routed through other persons and entities. As Section 7C was mainly introduced to counter the avoidance of tax with estate planning, it will not apply to all trusts. Certain trusts for example Vesting Trusts, Trusts that hold a primary residence, Special trusts etc. are excluded from the application of these rules.
Interest foregone in respect of interest free or low interest loans made to trusts will be treated as an ongoing and annual donation made by the natural person to the trust. Interest foregone will be determined as the difference between interest that would have been payable by the trust had interest been charged at the official rate (currently 8% as per the Seventh Schedule to the Act) and the actual interest charged by the lender. Donations tax at 20% will therefore only apply on annual donations in excess of the primary exemption of R100 000 per annum. As 8% of R1 250 000 is R100 000, loans below R1 250 000 will not give rise to donations tax. Furthermore no deduction, loss, allowance or capital loss may be claimed by the taxpayer in respect of the interest free or low interest loan made to the trust.
It is therefore important to consider existing and new trust structures carefully to ensure continued the effectiveness of such trusts as estate planning tool from a tax perspective.
Anke De Wet