Section 7C of the Income Tax Act which came into effect on 1 March 2017 will impact trusts extensively. In the past it was common practice for a trust to acquire assets via an interest-free or low interest loan from a natural person. The objective of Section 7C is to tax loans by related parties (founders, beneficiaries etc.) to the trust, if these loans attract interest at a rate lower than the official rate of interest (currently 8%). The new provision seeks to address the avoidance of estate duty and donations tax.
Functioning of Section 7C: By disposing of growth assets on an interest-free loan to a trust, individuals would limit their estate duty to the value of the loan account at the date of disposal. Any growth in the value of the asset after disposal would accrue to the trust and hence not be subject to estate duty. Should Section 7C be invoked on a related party loan, SARS will deem the interest to be a donation made by the related party to the trust. The interest will be calculated at a rate of 8% on the outstanding loan balance less any interest actually paid. This donation will attract donations tax at a rate of 20%, payable by the related party lender. Loans to the following Trusts are excluded from the application of this new provision: If the trust represents an official public benefit organization, or is established solely for the benefit of persons with disabilities. Vesting trusts where the rights of beneficiaries are clearly established, to the extent that a loan is used by the trust for funding the acquisition of the primary residence of the lender. International loans where non-arms’ length loans are subject to adjustment in terms of special tax rules in Section 31 of the Income Tax Act. Loans in terms of Sharia compliant financing arrangements. Loans which are deemed to be dividends.
Practical example of donations tax under Section 7C:
Notes: *We are of the opinion that interest-free loans arising from historic distributions to beneficiaries will be excluded from the provisions of Section 7C. However, separate disclosure in the financial statements of loans arising from distributions and by other means is essential and will require a historical reconciliation. #Individuals are exempt from donations tax on the first R100 000 donated per annum. This has the effect that any loan below R1 250 000 will not attract donations tax if we assume that an individual did not make any other donations during the year of assessment (8% of R1 250 000 is R100 000).
Contact one of the Directors at C2M Chartered Accountants Inc. to discuss the implications specifically applicable to your Trust and circumstances. We will advise you not only on the most tax efficient solution but also how to structure future transactions in order to minimize estate duty.
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