Tax proposals to hit low interest loans to trusts

By David Warneke, Head of Tax Technical, BDO South Africa 

The Draft Taxation Laws Amendment Bill of 2016 includes far-reaching proposals relating to the

Income tax treatment of low interest or interest free loans to trusts. The proposals, if enacted, could

lead to the unwinding of various trust structures.

The proposed wording (contained in a new section 7C of the Income Tax Act), if enacted and the preconditions

are met, could result in the following:

  1. The difference between the interest actually charged on the loan and interest at the “official

rate” , would be included in the income of a natural person (usually the actual lender where

the actual lender could be a company that is a “connected person” in relation to the natural

person (see below));

  1. The amount included in the income of the lender is not deemed to be interest and the tax

exemption relating to interest would not allow offset;

  1. The income tax payable by the natural person following inclusion of this amount in taxable

income must be recovered by that person from the trust within three years after the end of

the year of assessment. If not, the amount will be treated as a donation by that person to the

trust and potentially subject to donations tax;

  1. The trust will not receive a corresponding deduction against taxable income;
  2. Where lenders forgive R100 000 per annum of their loans to trusts to use the annual donations tax exemption will not be treated as exempt; and
  1. No deduction, loss or allowance will be available to a lender as a result of the failure of thetrust to repay a loan, advance or credit if subject to this section.

The proposed section would come into operation on 1 March 2017 and would apply in respect of tax

years commencing on or after that date. When read with the pre-conditions which are drafted in the

present tense, this may be interpreted that it may only apply to loans, advances or credit advanced during years of assessment commencing on or after 1 March 2017. However, it is doubtful that this

limited application is intended.

The pre-conditions are: 

  • If a natural person directly or indirectly provides a loan, advance or credit to a trust in

relation to which that person or any “connected person” in relation to that person is a

                “connected person”; or

  • If instead of a natural person providing the loan, advance or credit, a company that is a

“connected person” in relation to the natural person is used to provide the loan, advance or

credit to the trust. In technical terms, the proposal expresses this intent in the form that the

provision would apply if the loan, advance or credit is provided directly or indirectly by a

company in relation to which a natural person is a “connected person” and if the company or

any person that is a “connected person” in relation to the natural person or the company is a

“connected person” in relation to the trust. It is submitted that the proposal probably overreaches

itself in its current form as it leads to various anomalies.

A natural person is a “connected person” in relation to a trust if the natural person is a beneficiary

of the trust or if a “relative” of the natural person is a beneficiary of the trust. So if a loan is made

to the trust by a natural person who is not a beneficiary of the trust but if his children are

beneficiaries, the section could apply. It could also apply if a natural person owns 20% or more of the

shares of a company that advances a loan to the trust of which the natural person’s sister is a

beneficiary.