The National Treasury and SARS published the 2016 Draft Taxation Laws Amendment Bill on 8 July 2016. The Bill introduces a new section - Section 7C - to the Income Tax Act (‘the Act’) which provides detail and measures to prevent Estate Duty and Donations Tax avoidance through the transfer of assets to a Trust on interest-free loan account.
When transferring assets to a Trust, a person has the following three options, each giving rise to different tax consequences:
- A person can donate the assets to the Trust and trigger Donations Tax at 20% of the fair market value of the assets in the hands of the person. The attribution rules contained in sections 7(3) to 7(8) may also apply to any income earned by the Trust as a consequence of the donation and have the effect of taxing such income in the hands of the donor;
- A person can sell the assets to the Trust on loan account at an arm’s length interest rate. The transferor will be taxed on the interest received from the Trust and there could be scope for the Trust to deduct the interest expenditure to the extent that is incurred in the production of income; or
- A person can sell the assets to the Trust on loan account at an interest rate below that considered to be an arm’s length rate. Traditionally, such loans have, in many cases, been interest-free.
The last option results in a reduction of Estate Duty and also results in the avoidance of Donations Tax.
In addition, the transferor has had the scope to reduce the loan capital by donating amounts to the Trust to be offset against the loan using the current provisions of section 56(2)(b) of the Act which provides for exemption from Donations Tax on annual donations of up to R100 000. The fact that no interest is paid by the Trust means that the transferor is also not exposed to tax on income that would otherwise have arisen in his hands, unless the attribution rules referred to above apply.
The direct impact of this is that it has the potential to further decrease the tax base.
The proposed new section 7C is designed to prevent the avoidance of tax which arises under option 3 outlined above. The section applies where any natural person, or a company in relation to which that person is a connected person (most commonly a company in which the natural person holds at least 20% of the equity share capital), provides any loan, advance or credit to any Trust. If the loan is interest-free or if the interest rate charged is less than the official rate (currently 8%), the shortfall will be taxable in the hands of the lender but it will not be deductible by the Trust. Such amount imputed as income in the hands of the lender will also not qualify for the section 10(1)(i) interest exemption. The lender may recover the tax paid on the deemed income from the Trust. If the lender does not do so within three years, the amount will be deemed to be a donation in the hands of the lender and subject to 20% Donations Tax.
In addition, the lender is prohibited from claiming any capital loss which may arise as a result of the reduction or waiver of, or failure on the part of the Trust to repay, the debt. Furthermore, the annual exemption of the first R100 000 of donations, will not apply where the lender donates any amount which reduces the loan capital.
The new section is still in “Bill form” and might change before the final Act is promulgated, but Grant Thornton’s Tax advisors do not expect any drastic changes.
Fortunately, the proposed amendments will apply only in respect of years of assessment commencing on or after 1 March 2017. There is still time then, albeit limited, to make changes to your current structure if required.
To discuss how these provisions might apply to your Trust structure and for further information on which changes could be put in place before 1 March 2017, please contact: Carin Grobbelaar.