National Treasury implemented an anti-avoidance measure, with effect from 1 March 2017, which was aimed at curbing the tax-free transfer of wealth to trusts through the use of low interest or interest-free loans, advances or credit.
The latest Draft Taxation Laws Amendment Bill, issued on 19 July 2017, seeks to extend the ambit of section 7C of the Income Tax Act, in respect of a loan, advance or credit provided to a trust.
Under section 7C of the Income Tax Act (the Act), an ongoing and annual donation is triggered whenever interest-free or low-interest loan, advance or credit is made to a trust by:
- a natural person; or
- a company that is a connected person in relation to a natural person that advanced the loan, advance or credit to the trust at the instance of that natural person.
For section 7C to apply, such a natural person or company that advances the loan, advance or credit, should be a connected person in relation to the trust, or the natural person must be a connected person in relation to another person that is a connected person in relation to the trust.
This ongoing and annual donation is taxed in the hands of the natural person at a rate of 20%, even when the company advances the loan, advance or credit to the trust.
In every year of assessment of the trust that the interest-free or low-interest loan remains outstanding, the amount of the deemed donation made by the natural person to the trust is determined by calculating the difference between the interest charged on the loan, advance or credit and the interest that would have been payable by the trust had the interest been charged at the official rate of interest (as defined in the Seventh Schedule to the Act).
To date, taxpayers have employed various measures in an attempt to overcome the application of section 7C.
Two such measures have caught the attention of both SARS and National Treasury and these have now been highlighted in an effort to curb such actions. The latest Draft Taxation Laws Amendment Bill addresses these so-called ‘schemes’.
- The first scheme involves the taxpayer advancing an interest-free or low-interest loan to a company whose shares are held by the trust. By advancing the loan to the company instead of to the trust, the anti-avoidance measure in section 7C does not apply as the loan has not been advanced to the trust directly.
- The second scheme identified involves taxpayers entering into an arrangement under which the loan claim of the natural person who made the loan, advance or credit to the trust (or the natural person at whose insistence a company made a loan to a trust) is transferred to another natural person. The natural person that the loan claim is transferred to is usually a current beneficiary of the trust or a future beneficiary of the trust to which the loan, advance or credit is made. An example of such an individual would be a child or a spouse who is a current or future beneficiary of the trust. By subsequently transferring the loan claim, taxpayers argue that this breaks the link between the natural person who advanced the loan to the trust and therefore the loan would successfully fall outside the ambit of section 7C regulations.
In order to curb the abovementioned avoidance, an extension of the provisions of section 7C is proposed in the Draft Taxation Laws Amendment Bill, whereby interest-free or low-interest loans, advances or credit that are made by a natural person or a company (at the instance of a natural person) to a company that is a connected person in relation to a trust should also fall under the anti-avoidance measure.
To curb the second scheme, it is now proposed that where a person that is a connected person in relation to a trust acquires a claim to an amount owing by that trust in respect of a loan, advance or credit that was originally advanced by a natural person or a company (at the instance of a natural person) to that trust, the person who acquires that claim will be deemed to have advanced the amount of that claim as a loan on the date that person acquired that claim.
Unfortunately, these proposed extensions of section 7C’s ambit is likely to cause a new headache for those taxpayers that would have taken steps to fall outside of its application. In addition, a rethink on any restructuring that was effected is most certainly going to be needed. Certain taxpayers that may not have fallen foul of the original provisions of section 7C could now also be affected.
The proposed amendment is effective from 19 July 2017 and applies in respect of any amount owed by a trust or company in respect of a loan, advance or credit provided to that trust before, on or after that date. It should be noted that these proposals are yet to be finalised.
For further information or for assistance with implementation of the changes and dealing with any historical position, please contact Eugene du Plessis from our tax team.