“For estate planning purposes a few years ago I moved some of my assets into a family trust and financed the disposal to the trust with an interest free loan in my name. I understand that recent tax amendments will now impose unfavourable tax consequences on me in relation to this interest free loan. Is this true?”
You are correct. A new Section 7C has been introduced into the Income Tax Act 58 of 1962 as an anti-avoidance provision to discourage the use of trusts for estate planning purposes. Section 7C is effective from 1 March 2017 and will apply to any loans, advances or credit provided either directly or indirectly by certain persons to their trusts, before, on or after 1 March 2017.
Traditionally, the disposal of assets to a trust by way of a low interest or interest free loan would not trigger adverse tax consequences for the individual or the trust. The loan could be discharged over the period of a few years by natural persons donating R100,000.00 per year to the trust (such donation amount is exempt from tax). This estate planning mechanism allowed individuals to reduce their asset base by employing the exemption from donations tax to extinguish the loan and reduce their tax base.
Section 7C now applies where there is an interest free loan or a loan which is repayable at an interest rate below the official rate (currently set at 8%) by certain connected persons to their trusts. The difference between the set interest rate and the official rate is regarded as a donation which will attract donations tax levied at a rate of 20%.
A natural person as well as companies that are connected persons in relation to a natural person, or any other person that may be regarded as a connected person in relation to a natural person or company, will be regarded as “connected persons” for the purposes of section 7C. Section 7C then prevents the individual from claiming any deduction, loss, allowance or capital loss in respect of the loan to the trust, resulting in individuals being barred from cancelling or waiving loans which would have the effect of reducing their asset base for estate duty purposes.
It can be noted that natural persons are not precluded from employing the annual donations tax exemption of R100,000.00 to a donation to the trust. Should an individual therefore make a donation to their trust of R100,000.00 or less, section 7C will not be applicable and no interest will be deemed to have accrued to the particular individual. The aforesaid amount will not be owed by the trust to the individual in terms of a loan and no interest will be incurred by the trust. An interest free loan of R1,250,000.00 may therefore still be made by connected persons to their trusts, since at an interest rate of 8%, this amount will attract interest of R100,000.00, which in terms of the above mentioned exemption will preclude liability to pay donations tax.
It is clear that section 7C will impact dramatically on the effectiveness of using a trust as a vehicle for estate and tax planning purposes. It may therefore be necessary for you to contact your tax specialist to assist you in reviewing your current estate planning in the light of section 7C.
This article first appeared on the Phatshoane Henney Attorneys’ March 2017 newsletter.