It must be noted that the new section will apply in respect of any loan or advance made by a natural person or at the behest of such person by a company in relation to which a natural person is a connected person under the definition of connected person contained in section 1 of the Act to a trust.
It must be noted that the new section applies in respect of all loans made on, after, or before 1 March 2017 and therefore applies in respect of pre-existing loans on which no interest is charged.
The legislation provides that where a natural person makes an interest-free loan to a trust, the non-charging of interest will be regarded as a donation subject to donations tax at the rate of 20%.
The benchmark to be used for purposes of ascertaining whether the section applies is the so-called official rate of interest as defined in paragraph 1 of the Seventh Schedule to the Act which currently amounts to 8% per annum. Thus, where a natural person makes an advance or loan available to a trust to acquire assets and no interest is charged, that person will be liable to donations tax on an amount of 8 % of the loan advanced to the trust for each year during which the loan is in existence.
Should interest be charged at a rate lower than the official rate, the difference will attract donations tax in the hands of the natural person.
Thus, where a natural person advanced funds to a trust in an amount of R10 000 000.00 and chooses not to charge interest thereon from 1 March 2017, that will constitute a donation of R 800 000.00 for the 2018 tax year which will result in a liability of donations tax amounting to R 160 000.00 per annum, ignoring for the moment the fact that the first R100 000.00 of donations are exempt from donations tax. Where a loan advanced to a trust does not exceed an amount of R1 250 000.00, 8% thereof amounts to R 100 000.00 and the taxpayer would be entitled to rely on the exemption of donations tax, which exempts the first R100 000.00 from donations tax.
The donation will be regarded as having been made to the trust by the natural person on the last day of the year of assessment of the trust and donations tax will be payable by the end of the month following the month during which the donation takes effect. Thus the donations tax will be payable by 31 March 2018. The new rules also apply where, for example, a natural person makes a loan to a company to which the natural person is connected and that company in turn, directly or indirectly provides those funds to a trust.
Section 7C(5) provides that no donations tax will arise in respect of loans or advances where:
• the trust is a public benefit organisation approved by the Commissioner under section 30(3) of the Act or a small business funding entity approved by the Commissioner under section 30C;
• the trust is a special trust as defined in paragraph (a) of the definition of special trust;
• the trust used the loan wholly or partly for purposes of funding the acquisition of an asset and the natural person or their spouse used that asset as a primary residence as envisaged in the definition of primary residence in the Eighth Schedule to the Act and the amount owed relates to the part of that loan that funded the acquisition of that residence;
• that loan or advance was provided to that trust in terms of an arrangement that would have been regarded as asharia compliant financing arrangement as referred to in section 24JA of the Act.
• that loan or advance is subject to the provisions of section 64 E(4) relating to deemed dividends under the dividends tax rules;
• that loan or advance comprises an affected transaction as referred to in section 31(1) which is subject to the provisions of that section;
• that loan or advance was provided to that trust by a person as a result of the vested interest held by that person in the receipts and accruals of the assets of that trust and the conditions specified in section 7C (5)(b) of the Act are complied with.
Where the natural person makes a loan to a foreign trust and does not charge interest thereon, that loan is subject to the provisions of section 31 and on that basis section 7C should not apply. It is important that where a loan is made available by a South African tax resident to a foreign trust that interest is charged at a rate that would have been charged by person’s dealing at arms’ length thereby complying with the provisions of section 31 of the Act.
|Should interest be charged at a rate lower than the official rate,
the difference will attract donations tax in the hands of the natural person.
Thus, where a natural person has advanced funds to a trust, it is necessary to review the annual financial statements of the trust to decide what to do and where the trust owns an asset producing income, it may make financial sense to charge interest on the loan which would then ensure that the trust receives a deduction for interest payable to the natural person but remembering that the interest paid will be taxable in the hands of the natural person. It is not possible to generalise and state what course of action a person should follow where they have made an advance available to a trust as it does depend on the totality of the circumstances and it will be necessary to review the taxpayer’s personal situation as well as that of the trust to determine what should be done to alleviate the donations tax that would otherwise become payable if no interest is charged on the loan due by the trust to the natural person.
The question often that arises is whether an amount payable to a beneficiary as a result of an award or distribution made by a trust but not actually paid in cash to the beneficiary will also be subjected to the rules contained in section 7C.
The Explanatory Memorandum on the Taxation Laws Amendment Bill published by Natural Treasury on 15 December 2016 indicates that an amount which is vested irrevocably by a trustee in a trust beneficiary, which is used or administered for their benefit will not qualify as a loan or credit provided by that beneficiary to the trust where the vested amount may, in accordance with the trust deed, not be distributed to that beneficiary for example before the beneficiary reaches a specific age, or that the trustee has the sole discretion in terms of the trust deed regarding the timing of and extent of any distributions to that beneficiary of such vested amount.
The Explanatory Memorandum points out that where an amount vested by a trust in a trust beneficiary, which is actually distributed to the beneficiary will qualify as a loan under section 7C where the non-distribution results from an election made by that beneficiary or request by the beneficiary that the amount not be distributed or paid over. It will therefore be necessary to review the trust deed to establish whether awards made, other than cash, to a beneficiary fall within the rules of section 7C or not.
It must be noted that section 7C will apply so long as the loan remains in place between the trust and the natural person which can become expensive when one considers that donations tax at the rate of, currently, 20% will be paid on the interest foregone on the loan made by the natural person to the trust for so long as the loan is in existence. Persons who have interest-free loans in place with a trust should review their position as a result of section 7C.
Dr Beric Croome is a Tax Executive at ENSafrica. This article first appeared in Business Day, Business Law and Tax Review, March 2017. Image purchased www.iStock.com ©iStock.com/"Retirement Savings" by michellegibson