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SECTION 7C OF THE INCOME TAX ACT
Many clients, especially those who have a significant number of assets, have over the years, created trusts. They have done so to benefit and administer their estates in such a way to minimise risk and, due to common law and legislation, draw on the tax benefits it offered.
Most donors choose to sell or donate property to their trusts for tax-planning purposes. Donating property is far less beneficial nowadays because tax laws only allow for a R100,000 donation tax exemption when a person donates an asset to a trust. The donation is also taxed at 20% of the value of the donation. Generally, this method is too expensive. As another option, a person may sell the asset to a trust by way of a loan account. Subsequently, the trust will record a loan in favour of the seller and the loan will not be subject to any interest or, at most, a below-market interest rate. The effect being that the trust pays market-related interest, resulting in income in the hands of the seller, who would then have to include that in their taxable income for the year of assessment. In some cases, it may be structured in such a way that the seller pays little to no interest, then that portion of personal income is reduced, and less personal income tax is payable. From a South African Revenue Service (SARS) and, ultimately, the Department of Treasury’s point of view, it is an important source of income.
In the Act, Section 7C specifically addresses the issue whereby a loan, credit or an advance is granted to a trust at no interest or below market-related interest rates. The section is structured in such a way that it allows for no recoupment on losses or the deduction of real expenses and, as a result, it deems the difference in interest rates (actual rates versus the official rate of interest per Schedule 7 of the Income Tax Act) as a donation to the trust.
In summary, Section 7C is an anti-avoidance mechanism, other than being a guideline, when dealing with loans to trusts. Section 7C came into effect on 1 March 2017.
Interest-free loan to trust: R10million
Donation: R10 million x 8% interest at the SARS official rate = R800 000
Donations tax: (R800 000 – annual exemption R100 000) x 20% = R140 000.
Donations tax at 20% will only apply on annual donations (whether to trusts or others) over and above 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).
The two most likely scenarios in line with this legislation, which may apply to your client, are as follows:
Indirect loans to trusts will be subject to Section 7C. An example of this would be when you advance an amount to someone who is not a connected person to you (Y), subject thereto that Y will advance an interest-free loan to the trust and cede the claim for repayment by the trust to you as security for repayment of that loan.
Section 7C should not apply in the instance where trustees credit distributions on a loan account to a beneficiary, and the payment of the loan is in the sole discretion of the trustees. The trust deed should also allow the trustees to do so. There must be no contract of loan between the trustees and the beneficiaries for this transaction agreeing on the terms applicable to the retention of the vested amount in trust. The beneficiaries must have no say in whether or when the amount vested in them should be distributed to them.
Loans to the following are excluded from the application of this new provision:
Careful consideration should be given before new trust structures are created and existing structures should be carefully examined to ensure their continued effectiveness from a tax point of view. The many other valid reasons for the use of Trusts may well override any negative tax consequences, provided that the trust is structured and administered correctly.
Main sources: EM de Vos, Trust Manager, Legatus Trust
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