If you have an interest free loan or low interest loan which is owed to you or your company from a Trust, then you need to pay attention, as failure to do so could result in an unwanted tax liability come the end of February 2018.
Section 7C of the Taxation Laws Amendment Bill came into effect on 1st March 2017 and applies retrospectively. The purpose of this new tax law is to address Estate Duty avoidance by deeming the interest not paid by a trust on an interest free or low interest loan as a donation in the hands of the lender (usually the Donor).
Mr Donor loans to his Family Trust the sum of R 10 000 000 (ten million Rand) as part of an estate planning exercise to purchase a share portfolio. The loan is interest free and payable on demand. The resultant donations tax liability is illustrated below, as follows:
Step 1: Calculate the deemed interest: R 10 000 000 x 7.75% (official rate) = R775 000
Step 2: Deduct the annual donations tax allowance available to natural persons in the sum of R 100 000 (assuming no other donations were been made during the tax year) = R 775 000 – R 100 000 = R 675 000
Step 3: Calculate the donations tax payable: R 675 000 x 20% (rate for donations tax) = R135 000
The donations Tax liability payable at the end of the tax year = R 135 000
Where section 7C does not apply:
There are a number of instances where section 7C will not apply to interest free or low interest loans to trusts. These exemptions are summarised and set out below, as follows:
- Any loan to a trust which is an approved Public Benefit Organisation or Small Business Funding Entity;
- Any loan to a trust by a person by reason of or in return for a vested interest held by that person in the receipts and accruals and assets of the trust;
- Any loan to a trust which qualifies as a Special Trust;
- Any loan to a trust where the loan, wholly or in part, was used to fund the acquisition of a primary residence as defined in the Act;
- Any loan to a trust which constitutes an affected transaction as defined in section 31(1) of the Act i.e. transfer pricing;
- Any loan to a trust in terms of an arrangement that would have qualified as a Sharia compliant financing arrangement as contemplated in section 24JA of the Act, had that trust been a bank as defined in that section; and
- Any loan to a trust which is subject to the provisions of section 64E(4) of the Act i.e. deemed dividend provisions.
Glaringly, section 7C does not apply to interest free or low interest loans to companies which are trust owned, which ‘loophole’ has seen many individuals looking to restructure into this space to avoid the resultant donations tax liability. However, this re-structuring option may be short lived, as the recently published Taxation Laws Amendment Bill intends to address this loop-hole.
To mitigate and avoid any tax surprises come the end of the current tax year, it is important to seek the required expert legal advice to understand how section 7C will affect your pocket and to ensure that all re-structuring options are explored, taking into account your personal circumstances and your estate planning needs and objectives.
Going forward, it is now more important than ever to reduce to writing the terms and conditions of any loan to your trust under a properly drafted loan agreement, as no doubt SARS will be calling for these documents in support of submissions made in your personal and your trust’s tax returns.
Please do not hesitate to contact any one of our Fiduciary attorneys for assistance.