INTEREST FREE LOANS WITH COMPANIES

A4bThe latest annual nation budget presented in Parliament proposed the dividends tax rate to be increased with almost immediate effect from 15% to 20%. The increased rate brings into renewed focus what anti-avoidance measures exist in the Income Tax Act[1] that seeks to ensure that the dividends tax is not avoided.

Most commonly, the dividends tax is levied on dividends paid by a company to individuals or trusts that are shareholders of that company. To the extent that the shareholder is a South African tax resident company, no dividends tax is levied on payments to such shareholders.[2] In other words, non-corporate shareholders (such as trusts or individuals) may want to structure their affairs in such a manner so as to avoid the dividends tax being levied, yet still have access to the cash and profit reserves contained in the company for their own use.

Getting access to these funds by way of a dividend declaration will give rise to such dividends being taxed (now) at 20%. An alternative scenario would be for the shareholder to rather borrow the cash from the company on interest free loan account. In this manner factually no dividend would be declared (and which would suffer dividends tax), no interest accrues to the company on the loan account created (and which would have been taxable in the company) and most importantly, the shareholder is able to access the cash of the company commercially. Moreover, since the shareholder is in a controlling position in relation to the company, it can ensure that the company will in future never call upon the loan to be repaid.

Treasury has for long been aware of the use of interest free loans to shareholders (or “connected persons”)[3] as a means first to avoid the erstwhile STC, and now the dividends tax. There exists anti-avoidance legislation; in place exactly to ensure that shareholders do not extract a company’s resources in the guise of something else (such as an interest free loan account) without incurring some tax cost as a result.

Section 64E(4) of the Income Tax Act provides that any loan provided by a company to a non-company tax resident that is:

  1. a connected person in relation to that company; or
  2. a connected person of the above person

“… will be deemed to have paid a dividend if that debt arises by virtue of any share held in that company by a person contemplated in subparagraph (i).” (own emphasis)

The amount of such a deemed dividend (that will be subject to dividends tax) is considered to be effectively equal to the amount of interest that would have been charged at prime less 2.5%, less so much of interest that has been actually charged on the loan account.

It is important to also appreciate that the interest free loan capital is not subject to tax, but which would also have amounted to a once-off tax only. By taxing the interest component not charged, the very real possibility exists for the deemed dividend to arise annually, and for as long as the loan remains in place on an interest free basis.

[1] 58 of 1962

[2] Section 64F(1)(a)

[3] Defined in section 1 of the Income Tax Act

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)

INTEREST FREE LOANS TO DIRECTORS

A3bIt is very often the case that a company extends an interest free or low interest loan to a director. This manifests either as a true incentive or benefit to that director (mostly the case in larger corporate environments) or in a small business environment in lieu of salaries paid. The latter is especially the case for example where a spouse or family trust would hold the shares in the company running the family business, but which business is conducted through the efforts of the individual to whom a loan is granted from time to time.

In terms of the Seventh Schedule to the Income Tax Act[1] a director of a company is also considered an “employee”.[2] This is significant, since directors can therefore also be bound by the fringe benefit tax regime applicable to employees generally.

Paragraph (i) of the definition of “gross income” in the Income Tax Act[3] specifically includes as an amount subject to income tax “the cash equivalent, as determined under the provisions of the Seventh Schedule, of the value during the year of assessment of any benefit… granted in respect of employment or to the holder of any office…”

Clearly, benefits received by a director of a company would therefore rank for taxation in terms of this provision. The question remains therefore whether loans provided to such directors by the companies where they serve in this capacity would amount to such a taxable benefit, and further how such benefit should be quantified.

Paragraph 2(f) of the Seventh Schedule is unequivocal in its approach that a taxable fringe benefit exists where “… a debt … has been incurred by the employee [read director], whether in favour of the employer or in favour of any other person by arrangement with the employer or any associated institution in relation to the employer, and either-

(i) no interest is payable by the employee in respect of such debt; or

(ii) interest is payable by the employee in respect thereof at a rate of lower than the official rate of interest…”

Paragraph 11 in turn seeks to quantify the amount of the taxable fringe benefit to be included in the gross income of the director. Essentially, the taxable fringe benefit would be equal to so much of interest that would have been payable on the loan at the prime interest rate less 2.5%, less any interest actually paid on the loan. The benefit therefore does not only arise on interest-free loans, but also on loans carrying interest at less than the prescribed interest rate.

It is necessary to note that a fringe benefit otherwise arising will not be a taxable benefit if the loan amount is less than R3,000, or if it is provided to the director to further his/her studies.

[1] 58 of 1962

[2] Paragraph 1 of the Seventh Schedule, paragraph (g) of the definition of “employee”

[3] See section 1

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)

INTEREST FREE LOANS AND TRUSTS

A2bThe recent introduction of section 7C to the Income Tax Act[1] brought the taxation of trusts, and the funding thereof specifically, under the spotlight again. Briefly, section 7C seeks to levy donations tax on loans owing by trusts to connected parties (typically beneficiaries or the companies they control). To the extent that interest is not charged, a donation is deemed to be made by the creditor annually amounting to the difference between the interest actually charged (if at all), and interest that would have been charged had a rate of prime – 2.5% applied.

What many lose focus of is that interest free (or low interest) loans have income tax consequences too, over and above the potential donations tax consequence arising by virtue of section 7C. Section 7 of the Income Tax Act is specifically relevant. This section aims to ensure that taxpayers are not able to donate assets away and which would rid themselves of a taxable income stream.

In broad terms, section 7 deems any income that accrues to a trust or beneficiary to be the income of the donor if the income accrues from an asset previously the subject of a “donation, settlement or other disposition”. In other words, where a person donates a property to a trust, the rental income generated will not be taxed in the hands of the beneficiary or the trust, but in the hands of the donor. Section 7 therefore acts as an anti-avoidance provision to ensure that taxpayers do not “shift” tax onto persons subject to less tax through donating income producing assets out of their own estates.

It is interesting to now consider what an “other disposition” would amount to. Various cases have confirmed that an interest free loan would be treated as such and that, to the extent that interest is not charged, this would amount to a continuing donation.[2] The implication thereof is this: assume the funder of a discretionary trust sells a property to that trust on interest free loan account. Any rental earned would ordinarily have been taxed in the hands of the trust or the beneficiary, depending on whether distributions will have been made. However, since section 7 will apply to the extent that no interest was charged on the loan account, a portion of the rental income will now be taxable in the hands of the trust funder.

The take-away is that donations to trusts have income tax implications for the donor too, over and above a donations tax consequence. This will also be the case where interest free loans are involved.

[1] 58 of 1962

[2] Honiball and Olivier, The Taxation of Trusts (2009) at p. 84 and following

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)

THE BUDGET 2017

A1bFollowing the annual national budget speech delivered by Finance Minister Pravin Gordhan on 22 February, we highlight some of the most significant matters arising below:

  1. A new tax bracket will be introduced targeting the wealthy as well as trusts. It is proposed that trusts will from now on be taxed at 45% on all taxable income, while individuals earning more than R1.5million per tax year will pay 45% income tax on such income (estimated to be around 103,000 individuals);
  2. The dividends withholding tax rate is proposed to be increased from 15% to 20%. This is linked to the above increase in individual income tax rates to prevent wealthy individuals from exploiting the arbitrage opportunity that may exist in receiving fees in a company and having these paid out as a dividend;
  3. The much debated VAT rate has been left unchanged, which was widely expected given the political sensitivity coupled with the effect that this may have on the poor;
  4. Increase in withholding taxes on non-residents disposing of immovable property situated in SA;
  5. The “duty free” threshold for transfer duty (tax levied on purchasers of immovable property) has been increased from R750,000 to R900,000;
  6. The corporate income tax, donations tax and estate duty rates have been left unchanged;
  7. The CGT inclusion rate (40% for individuals, 80% for companies or trusts) was left unchanged too;
  8. The above and other most significant changes can be summed up as follows:
  WAS NOW
Top marginal PIT rate 41% 45%
Dividends tax 15% 20%
Tax rate for trusts 41% 45%
Estate duty abatement R3.5 m R3.5 m
CGT annual exclusion R40,000 R40,000
Primary rebate for individuals R13,500 R13,635

The Minister also alluded to the following matters which could expect legislative intervention or refinement during the course of the year:

  1. Renewed focus on transfer pricing and cross-border tax avoidance schemes;
  2. Further refinements to anti-avoidance legislation introduced in 2016 as applies to trusts;
  3. Section 42 “asset-for-share” relief to be extended to also provide for the assumption of contingent liabilities (as opposed to only applying to the issuing of shares or the assumption of existing debt);
  4. Share issue and buy-back transactions (commonly used as part of corporate restructurings whereby CGT is avoided) are to be addressed as part of an anti-avoidance effort;
  5. The anti-avoidance provisions linked to “third-party back shares” (section 8EA) are to be relaxed;
  6. Further refinement and relaxation of the VCC regime as relates to rules restricting such investments;
  7. Measures will be introduced whereby foreign companies held by foreign trusts with SA beneficiaries will be drawn into the SA tax net under the “controlled foreign company” regime

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)