The renewed focus by National Treasury on the taxation of trusts was widely anticipated and it came as little surprise earlier this year that the first version of the Draft Taxation Laws Amendment Bill, 2016, introduced what will become the new section 7C of the Income Tax Act, 58 of 1962.
Much has since been written about the new provision, and many commentators have debated its merits, essentially attributing onerous tax consequences to low interest loans provided to trusts. The final version of the new provision, due to become effective 1 March 2017, has now been published by Treasury, and which will be incorporated into the Income Tax Act as soon as passing through the relevant legislative processes.
The final version contains quite a few significant changes to the initial proposal, although the aim of section 7C is still focused on attacking interest free loans to trusts.
To recap: loans extended by persons to connected party trusts at less than prime – 2.5% are potentially deemed to have donated an amount to that trust equal to the difference between interest that was actually charged and the amount of interest that would have been charged at a rate of prime – 2.5%. It is unlikely that such deemed donations will have any direct income tax consequences for the trust, although indirectly donations to trusts may cause certain receipts by a trust to be taxed in the hands of any donors in terms of the so-called “tax back” provisions contained in section 7 of the Income Tax Act. The obvious consequence of section 7C though is the potential incidence of donations tax.
In this regard, the first notable exception to the final version of section 7C is that the annual R100,000 exemption from donations tax may now be utilised against the deemed donation – said exemption was previous expressly excluded from being utilised against the deemed donation triggered by section 7C. Although this does not address the indirect income tax consequence highlighted above in relation to the application of the “tax back” provisions in the Act, it does significantly negate any potential donations tax consequences, while also removing the direct income tax consequence of the previous proposal in terms of which the creditor will have been deemed to have received an interest accrual in its own hands (and which would have been subject to income tax).
A further notable change to the final version of section 7C is that a long list of potential exemptions are now provided for where section 7C will not apply (although these are quite focussed and potentially of limited application only). It is finally also noted that the final proposed legislation makes it clear that the provision applies to loans already existing as at 1 March 2017, where doubt existed in terms of the previous proposal whether the provision would only have applied to “new” loans entered into on or after section 7C comes into effect.
The final version of section 7C presents a much diluted and less threatening version of the initial proposed legislation presented by Treasury earlier this year, and taxpayers will be relieved to learn of the significant concessions since been made. That being said, the provision still has the capacity to significantly increase the ultimate tax bill of a number of trust related structures, and our clients are once again encouraged to have their prevailing accounts reviewed to ensure that their affairs are structured appropriately.
 To the extent that a person donates an amount to the trust, income received by the trust as a consequence of that donation is deemed to accrue to the donor, and not the trust.
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)