Section 7C of the Income Tax Act is an anti-avoidance provision intended at limiting the tax-free transfer of wealth to trusts via the use of low-interest or interest-free loans, advances, or credit. The section was first introduced in 2016 to target schemes where taxpayers transferred assets to a trust against a loan, advance or credit which is left outstanding in favour of that taxpayer and on which no interest or low interest is charged. Alternatively, taxpayers would make an upfront low-interest or interest-free loan, advance or credit to a trust, and the trust would apply the funds to buy assets.
Taxpayers devised further schemes aimed at undermining these measures. To combat this abuse, revisions to tax legislation were implemented in 2017. As a result, interest-free or low-interest loans, advances, or credit given by a natural person or a company (at the instance of a natural person) to another company that is connected to a trust are subject to the anti-avoidance measure as well.
When section 7C finds application, an annual donation is triggered in the hands of the natural person who advances the loan or credit or in the hand of the natural person at whose instance a company advanced the loan or credit. The deemed donation made by the natural person to the trust is determined in each year of assessment of the trust that the interest-free or low-interest loan remains outstanding. The amount of the deemed donation is the difference between the interest charged on the loan, advance or credit and the interest that would have been payable by the trust had the interest been charged at the official rate.
Taxpayers are continuing to implement other variations of these structures in order avoid section 7C. In this case, the anti-avoidance measure is being circumvented by natural persons who subscribe for preference shares with no or low rate of return in a company held by a trust that is connected to those individuals. As a result, section 7C(1B) was added. When the scope conditions of the following two occurrences are satisfied, section 7C(1B) applies:
Scope 1 – Where a natural person who is a connected person in relation to the trust subscribes for preference shares in a company in which the trust holds at least 20% equity shares or voting rights (directly or indirectly).
Scope 2 – Where a natural person at his/her instance gives instruction to a connected company, to subscribe for preference shares in another company in which a trust holds at least 20% equity shares or voting rights (directly or indirectly) and the trust is a connected person in relation to the natural person or company that is subscribing for the preference shares.
The subscription price of the shares is deemed to be a loan to the company for section 7C purposes. The dividends accruing on the shares are deemed, for the purposes of section 7C purposes, to be interest on the deemed loan. The natural person will be deemed to have made a donation on the difference between the official interest rate and the deemed interest received (preference share dividends) in accordance with section 7C.
Section 7C(1B) applies from 1 January 2021 and is applicable in respect of dividends accruing during a year of assessment commencing on or after this date. Note, the section applies even if the subscription of shares took place before the section came into effect because the commencement date of the section refers to ‘dividends’ and not ‘subscriptions’. One must always look at the loan outstanding by the trust at year-end, hence the implications of section 7C(1B) is only effective from 1 March 2021 − that is, it applies for the first time in relation to the trust’s 2022 tax year.
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