We previously reported on the introduction of section 7C of the Income Tax Act, 58 of 1962. In terms of this targeted anti-avoidance provision, National Treasury sought to attack interest free loans granted to trusts by connected persons of that trust.
Typically, these loans would have arisen by virtue of an individual that would sell his or her asset to a trust of which he/she is a beneficiary for estate duty purposes on interest free loan account. By doing so, the asset’s value will grow in the trust, while the interest free loan will remain a non-appreciable, static asset in the hands of the beneficiary, thereby excluding future capital growth on the asset from estate duty when that individual should one day pass away.
Section 7C deems an interest component to arise on interest free or low interest loan accounts to the extent that interest is not charged at the prescribed rate. The amount of the deemed interest is then treated as an annual donation by the trust, thereby attracting donations tax on the value of the deemed donation made to the trust. Were the trust creditors to actually charge interest on the loans to the trusts on the other hand, this will lead to taxable income accruing in their hands, and which will be subject to income tax being charged thereon at prevailing income tax rates.
The new proposals contained in the draft Taxation Laws Amendment Bill, published on 19 July 2017, contain two significant reforms which further focus the extent of the anti-avoidance provisions of section 7C and counter two specific planning solutions being conceived in practice to counter the application of section 7C in its current form.
The first such proposal to take note of is that loans to trusts are no longer the sole target, but also interest free loans extended to companies (owned by trusts) by the beneficiaries of that trust. This is in an attempt to counter structuring solutions whereby loans owing by a trust were shifted by way of complex restructurings to companies owned by trusts.
The second proposal is aimed at loans due by trusts being transferred from the creditor individual to another, thereby effectively “breaking the link” between the person that extended the loan to the trust and the person now entitled to the amounts due by the trust. In other words, section 7C would only previously apply to the person who extended the loan to the trust. Since the person now holding the loan claim did not originally grant the loan to the trust, the provisions of section 7C, in its original form, would not have applied. The second new revision to section 7C counters this approach making it clear that a connected person acquiring a loan claim is also caught by the provisions of section 7C (and thus required to charge interest) irrespective thereof that that person did not itself extend any loan finance itself to the trust.
The above are still mere proposals, but are proposed to become effective 19 July 2017 if enacted (which appears likely). Taxpayers with loan accounts to trusts are therefore well-advised to seek guidance on how to treat such loan accounts going forward.
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)