In his Budget Speech of 2013, Minister Pravin Gordhan referred to the implementation of “… various measures proposed to protect the tax base and limit the scope for tax leakage and avoidance. “One such measure was”… the taxation of trusts will come under review to control abuse.”
On 26 October 2016 the Taxation Laws Amendment Bill was released. This Bill contains the proposed amendments to the Income Tax Act in the form of a new section, Section 7C, which speaks to the above statement.
In the past, a common estate planning mechanism was for the settler/founder of a trust to sell or loan his assets into a family trust/investment trust via interest free loan. There is no donations tax implication as the transaction is treated as a loan, and the estate duty liability in respect of the loan, potentially only arises on death.
The new section 7C, which covers loans or credits advanced to a trust by a connected person, will be applicable from 1 March 2017 on all loans made to trusts, prior to, on, or after that date.
The section will apply where a natural person (or a company that is a connected person in relation to that natural person) directly or indirectly provides a loan, advance or credit to a trust that is a connected person in relation to that natural person or company. It would also apply where the trust is a connected person in relation to another connected person of the natural person or company.
Loans to offshore trusts have historically (in accordance with SARS regulations) been subject to interest at a market related rate and therefore should not be adversely affected by these new regulations.
How will it work?
- Where the trust either:
– incurs no interest in respect of a loan, advance or credit;
– or interest is incurred at a rate lower than the official rate of interest (currently 8% *Note 1), an amount equal to the difference between the interest incurred and the interest that should have been incurred (taking into account the official rate of interest), will be treated as a donation made to the trust on the last day of the year of assessment of that trust, and subject to donations tax.
- The natural person is entitled to reduce this deemed annual donation, with the R100 000 donations tax exemption, provided the exemption has not already been utilised.
- For loans advanced by companies at the instance of natural persons, section 7C will only apply if that natural person, whether alone or together with any other connected person in relation to that natural person, holds at least 20% of the issued equity shares in or voting rights of that company.
- The attribution rules will continue to apply to any income and capital gains generated as a result of the application by the trust of the low interest or interest free loan.
- The effect is that the lender would pay donations tax annually on the interest below the official rate of interest, at the rate of 20% instead of the rate of 41% (income tax), and that the tax attribution rules will apply pro-rata.
- There are particular types of trusts that are exempt from the application of these provisions. These are:
– trusts that are approved Public Benefit Organizations
– special trusts established for the benefit of disabled persons
– certain vesting trusts
– loans to trusts where the funds are used for the purchase of a primary residence
– where the loan is an “affected transaction” and the transfer pricing rules in section 31 would apply
– where the loan is compliant with Sharia law
– where the loan is subject to dividends tax
This proposed legislation is a departure from the way loans to trusts have traditionally been treated, and therefore we encourage clients with zero interest or low interest loans to their trusts to consider the implications of these proposals and seek advice from their tax adviser in this regard.
In addition, please note that it is our understanding that the conduit principles in relation to trusts currently remain, unaffected.