It is common practice for a trust to acquire assets on a low or interest-free loan account from a natural person. The reason for capitalising the trust by means of a loan account is due to the fact that a newly set up trust will not have capital funding to acquire assets. The value of the asset sold to the trust is pegged at the outstanding loan account. The outstanding loan account instead of the value of the asset will form part of the estate at date of death for estate duty purposes. In some instances the loan account is reduced by the annual maximum donation tax exemption available to natural persons, which is currently R100 000.
If the anti-avoidance provisions contained in section 7(2)–7(8) and/or its counterparts contained in paragraphs 69–72 of the Eighth Schedule read with paragraph 73 of the Eighth Schedule find application, the low or interest-free loan could be attributed to the lender.
The Taxation Laws Amendment Bill 2016 inserts a new section 7C into the Income Tax Act. Section 7C finds application where a natural person has made a loan to a trust, low or no interest is charged to the trust on the loan, and the natural person is a connected person to the trust. A person is connected to the trust if he/she or any relative is a beneficiary of the trust. Section 7C will also be applicable where a company makes a low or interest free loan to the trust at the insistence of a person that is a connected person to the company and that person or company, or any connected person to that person or company, is connected to the trust. A person is a connected person to a company where that person holds individually or jointly with other connected persons directly or indirectly at least 20% of the equity shares or voting rights in the company.
Section 7C comes into operation on 1 March 2017 and applies in respect of any amount owed by a trust in respect of a loan, advance or credit provided to that trust before, on or after that date.
If section 7C is applicable, no deduction, loss, allowance or capital loss may be claimed in respect of the disposal of the loan account including the waiver of the loan or the failure to claim payment in respect of the loan account. In addition, the difference between official interest rate which is currently 8% and the low or no interest on the loan account will be deemed to be a donation made by the lender. The donation is deemed to have been made on the last day of that year of assessment of that trust. Donations tax will be payable at 20% on the deemed donation.
Section 7C is a specific-avoidance section and can be considered as a specific-avoidance within the boarder avoidance provisions of donations tax which is contained in Part V of the Income Tax Act. The abuse targeted is the avoidance of estate duty and donations tax.
Where a donation is deemed to have taken place in terms of section 7C, the taxpayer will still be entitled to make use of the R100 000 maximum annual exemption available to natural persons. The specific-avoidance therefore targets low or no interest loans made to trusts that is in excess of R1 250 000. Section 7C will not be applicable in certain situations.
Muneer Hassan CA(SA) is a Tax Consultant, Senior Lecturer in Taxation at UJ and lecturer on the Gauteng Board Course