Section 7C of the Income Tax Act, 1962 (“the Act”) was introduced to levy donations tax when assets are transferred by way of an interest free or so-called low interest loan to a trust. The implication of this section is that interest forgone on the loan is deemed as a donation with donations tax being levied thereon at a rate of 20%. But there are various reasons for the creation of a trust and the transfer of assets to it, and they are normally not pursued for the avoidance of any taxes, but with tax benefit results merely a consequence thereof. Some of these reasons would include succession and estate planning, placement of complex assets, protection of assets for minors or beneficiaries who are not financially astute or not mentally capable, and to protect a legacy for future generations.
Section 7C generally kicks in when an interest free or low interest loan, bearing interest below the SARS official rate, is advanced to a trust by a natural person or a company that is a connected person to the natural person who advances the loan to the trust.
The calculation of donations tax to be paid by the lender would be determined on the difference between the interest actually charged to the trust and the SARS official rate of interest on the outstanding value of the loan on the last day of each year of assessment, payable within 30 days of the end of each such year. The lender can use his/her annual donations tax exempt amount of R100 000 against section 7C donations tax.
Some exemptions when donations tax will not be levied for providing these loans to trusts include where the trust is a public benefit organisation, loans made to trusts in terms of a sharia compliant financing arrangement, or where the loan is used for acquiring an asset for purposes of being used as a primary residence of the lender.
Section 7C of the Act is in our opinion not applicable to a vested undistributed amount that is held in trust, as specifically explained and noted as excluded therefrom in line with the intention of the legislature in the SARS published Explanatory Memorandum on section 7C of the Act. Please note that there are Appeal Court and Constitutional Court judgements in South Africa on the applicability in practice of and reliance on Explanatory Memorandums of SARS. This vested amount will not qualify under section 7C for donations tax if the trustee, in terms of the trust deed, has the sole discretion as to the management in the trust and the distribution of said vested amount to the trust beneficiary. However, these vested amounts will trigger section 7C if the basis of such non-distribution is determined or agreed to by the said beneficiary. The reason why this exclusion is permitted is because the trust deed governs such action and the trustees unilaterally decide by way of resolution to vest the amounts in the beneficiary, and it accordingly does not constitute an agreement between the parties, as does a loan. The trustees should make sure that the vesting of amounts in this way in trust beneficiaries are allowed by the trust deed, that the resolution and decisions by the trustees to do so are worded correctly, and that the disclosure in the financial statements of the trust is done correctly as vested undistributed balances held and managed in the discretion of the trustees, and not incorrectly shown as loans.
There are a number of ways to minimise the potential effect of section 7C on loans to trusts, including but not limited to the repayment of the loan by the trustees (however, this places the assets back into the lender’s personal estate which consequently affects the protection previously enjoyed in the trust), make a donation to a spouse of a part of the loan, debt substitution or cession of the loan. These options are not considered as a one fit all solution and may be used in conjunction with one another, however each situation and structure will have to be evaluated on a case to case basis, due to the various contributing factors that can play a role therein. The lender has to also carefully consider whether the loan will be bequeathed in his/her will to the trust owing him/her or to someone else.
Section 7C has most definitely affected the use of trusts in estate planning: however it does not end the advantageous use of trusts, as often a necessity in legacy planning. It will however require careful consideration of the trust structure and administration thereof to ensure that the advantages are still available to the estate planner and his family. Contact marteen@fidelisvox.co.za to review your trust structure to make sure that you are optimising the benefits therefrom without exposing yourself to unnecessary risks.
This article is a general information sheet and should not be used or relied on as legal or other 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 legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)