FINAL AND DILUTED LEGISLATION IN RELATION TO LOW INTEREST LOANS AND TRUST

A1bThe 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.[1] 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.

[1] 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)

ASSET-FOR-SHARE TRANSACTIONS: TAX FREE RESTRUCTURE

a1bThe Income Tax Act, 58 of 1962, contains several so-called ‘group relief’ provisions in terms whereof corporate restructures can take place on a tax neutral basis. One of these is if a transaction comprises an ‘asset-for-share transaction’, or put simply: where a company purchases an asset in exchange for which that company agrees to issue shares to the seller.
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The term ‘group relief’ is somewhat of a misnomer in that not all of the group relief provisions necessarily involve groups of companies. The ‘asset-for-share transaction’ is one such an example where company groups are not necessarily involved. In fact, the concession (in section 42 of the Income Tax Act) is quite often used by individuals who are seeking to incorporate their businesses whereby they would transfer said business into a company in exchange for the latter issuing them with ordinary shares in that company. Such a transaction would not give rise to any immediate income tax costs, nor to any ancillary taxes such as VAT, Securities Transfer Tax, Transfer Duty, etc. (on condition that the relevant required formalities are observed).

The effect of an ‘asset-for-share transaction’ is effectively that the cost of the assets transferred are ‘inherited’ by the company. For example, assume Mr A has an asset with a base cost of R10 which is worth R100 today. He is able to transfer that asset to the company in exchange for shares without incurring any tax liability, but the company will be deemed to have acquired that asset at R10, and likewise Mr A his shares at the same price. The effect therefore is that when one day Mr A should sell his shares, or the company the asset, the capital gain on the original R10 cost would still be realised and consequently taxed at that stage. The tax implications linked to the asset is therefore not avoided altogether, but merely postponed.

A few requirements to qualify for a section 42 transaction includes:

  • The person to whom the shares are issued (i.e. the person selling the asset) must hold a ‘qualifying interest’ in the company subsequent to the transaction being concluded (being most often at least a 10% interest held in the company);
  • The company and the person disposing of the asset must typically hold the asset with the same intent. In other words, if the company will hold the asset as trading stock, then so too must the person disposing thereof have held the asset as such; and
  • The asset must be worth more than its base cost at time of the transaction being concluded.

Admittedly, this may be quite complex. To make matters worse, the provisions of section 42 apply automatically if its prerequisites are met and taxpayers are required to specifically elect out of its provisions if it does not want it to apply. All the more reason why any restructure would be incomplete without a review by a tax expert first before implementation thereof.

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)

HOME OFFICE EXPENDITURE

a4_bWith current day realities manifesting in ever increasing distances required to be travelled to get to an office, traffic congestion, etc. more and more employers are opting to give their employees the option of working from home. The proliferation of “home offices” has surfaced in dramatic fashion in recent times. It is therefore only natural that we have been experiencing an increased number of queries related to whether expenditure linked to home offices are tax deductible. With home office expenditure, we refer here specifically to those costs linked to occupying a specific space in a home for purposes of earning an income. This includes typically rent, interest paid on a bond, repairs, maintenance and other related costs.

Limitations to deductions for tax purposes in relation to home office expenditure is specifically dealt with by section 23(b) of the Income Tax Act, 58 of 1962. In essence it determines that home office expenditure is not deductible save in very strict circumstances, being:

  • where the part of the home used is used exclusively and regularly used for purposes of the taxpayer’s trade; and
  • on condition that the space so used must also have been specifically equipped for this purpose.

Home office expenditure will moreover not be deductible where the trade exercised involves employment or the holding of an office (such as a director for example), unless either:

  • the income earned is in the form of commission or any similar type of variable payment, and on condition that the duties of employment or office held are performed primarily outside of an office environment provided by an employer; or
  • the employment/office duties viewed holistically are mainly performed in the designated part of the home.

If either of the above two exceptions are met, home office expenditure will be deductible irrespective thereof that the taxpayer is an employee or the holder of a specific office. It is noted that section 23(m)(iv) in this regard also does not operate to limit deductions of home office expenditure more than is already the case in terms of section 23(b). (Section 23(m) ordinarily operates as the onerous provision severely limiting the tax deductions available to salaried individuals.)

As a final comment it should be pointed out that the above tests linked to whether home office expenditure is deductible or not all involves objective tests. SARS is also known to be extremely strict in its application of section 23(b). The Tax Administration Act, 28 of 2011, by virtue of section 102 provides that the burden of proof for showing that a deduction should be allowed rests on the taxpayer. SARS is therefore under no obligation to disprove any of the requirements necessary to qualify for home office expenditure. Rather, the taxpayer should be able to show that the space in question is exclusively and regularly used for business purposes and that it has been specifically equipped therefor. It should further illustrate that income earned comprises mainly a variable form of compensation and that no other space is available to the taxpayer, or that the services are performed mainly from the designated space at home.

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)

PROPOSED AMENDMENT TO THE TAXATION OF TRUSTS

a4_bNational Treasury published its much anticipated proposed annual amendments to tax legislation earlier in July. This year the proposed amendments were widely anticipated to shed led on Treasury’s proposals on how to address the perceived abuse of the trust form specifically going forward, especially as relates to the now well known ‘conduit pipe’ principle (in terms of which income received in a trust may ‘flow through’ the trust and instead be taxed in the hands of the trust beneficiaries). Many in the media, and some practitioners too, widely commented and bemoaned the widely anticipated demise of this well-entrenched South African trust law principle at the hands of Parliament.

Instead, a far more nuanced and focussed approach is proposed by the new section 7C of the Income Tax Act, 58 of 1962. In terms of this new proposed provision the conduit pipe principle is not at all affected, but rather low-interest (or interest-free) loans to trusts are being targeted. Briefly, any loan to a trust that is subject to interest at less than the prime lending rate less 250 basis points will be deemed to carry interest at that rate with interest accordingly accruing (and taxed) in the hands of the trust creditor. Consequently the trust creditor is taxed on deemed interest received, and that while typically the trust will be unable to claim a deduction on interest paid. To the extent further that the deemed interest gives rise to an increased income tax liability in the hands of the trust creditor, and the creditor does not recover said increased amount from the trust, the debtor is further deemed to have received a donation which in turn will be subject to donations tax at 20%.

We consider that the proposed amendments (proposed to be effective from 1 March 2017) should address two forms of perceived abuse of the trust for tax purposes:

  1. In the first instance, it is a common estate duty planning practice for an individual to sell assets on interest free loan account to a family trust to ensure that value-growth of the asset (and thus the estate) accumulates in the trust going forward, while the value of the estate of the individual remains the same. Individuals will now have to think twice before entering into these estate duty planning exercises: a sale on interest free loan account may very well still result in an estate duty saving ultimately (although ironically not effectively for the taxpayer but his/her heirs), but now at a cost of interest accruing to the individual throughout his or her lives and which is subject to income tax on an annual basis; and
  1. Secondly, the practice referred to as ‘income splitting’ is addressed (whereby trust distributions are made to various trust beneficiaries who are taxed at lower marginal tax rates): typically these distributions too would be made on interest free loan account, again therefore resulting in income tax consequences for the individuals in the form of ongoing income tax on the deemed interest received.

The public is invited to comment on the proposed amendments by 8 August. We are however of the view that Treasury is unlikely to make any significant concessions in this regard specifically. While we will keep our client base informed of any developments in this regard as appropriate, it may be prudent to contact us now already to start discussing how most efficiently to manage any risks emanating from the above proposals and as they may relate to existing trust structures post 1 March 2017.

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)

REGISTERING FOR PROVISIONAL TAX

Many taxpayers file their tax returns on an annual basis unaware thereof that they may be regarded as provisional taxpayers in terms of the Income Tax Act, 58 of 1962, too. In its simplest form, provisional tax exists to provide for regular cash flows to the fiscus throughout the year. In this sense it exists for very much the same purpose as the PAYE system, with provisional tax applying though typically to non-salary type income.

The following persons are considered provisional taxpayers in terms of the Fourth Schedule to the Income Tax Act, and are thus required to file provisional tax returns and make the attendant payments of provisional tax over and above those annual obligations which exist as relates to their annual income tax returns:

  • Every person (other than a company, but including a trust) who generally earns any income other than in the form of “remuneration” as defined;
  • Every company; and
  • Any person who is notified by the Commissioner for SARS that he or she is a provisional taxpayer.

The above however excludes:

  • Any natural person who does not derive any income from carrying on a business, if the taxable income for that person does not exceed:
    • the tax threshold (for 2016: R73,650 for individuals under 65, R114,800 for individuals under 75 and R128,500 for all other individuals); or
    • R30,000 as relates to interest, dividends or rent received from letting immovable property;
  • Deceased estates;
  • Certain approved public benefit organisations;
  • Body corporates; and
  • Small Business Funding entities.

Many taxpayers may be completely unaware thereof that they are required to file returns as provisional taxpayers. This is especially true of typically individuals earning a salary but for example letting a second property which they may own to earn a second income stream. These individuals will, based on the above prerequisites, have to ensure that they file bi-annual provisional tax returns and pay the requisite amount over to SARS in time (due by 31 August and 28/29 February each year). Failure to comply in this fashion will lead to significant penalties being incurred on late payment, or underestimation of the amount of provisional tax due: failure to submit a return when required is considered as the taxpayer having filed a return for Rnil.

As is the case for PAYE though, the provisional tax system does not operate as a tax per se but rather as the prepayment of a yet to be determined income tax liability. Therefore, once the ultimate amount of tax due for any given year of assessment has been determined after filing one’s annual income tax return, the resultant tax liability is reduced by provisional tax payments already made (and PAYE withheld) and the difference is then either due to SARS or to the taxpayer as a refund of the provisional tax paid too much.

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)

NEW PROPOSED TAX AMENDMENTS

National Treasury releases proposed amendments to tax legislation on an annual basis. Some of the most important of these are already foreshadowed when the Minister of Finance delivers his budget speech in Parliament. The proposals made in that Budget Review are then formalised into proposed draft tax legislative amendments in the form of the Draft Taxation Laws Amendment Bill and the Draft Tax Administration Laws Amendment Bill.

This year, after the budget speech on 24 February earlier this year, the proposed amendments were released by Treasury on 8 July 2016. We set out below some of the more significant proposed amendments:

  • As announced in the budget speech, targeted anti-tax avoidance legislation is introduced as relates to trusts. However, Treasury has opted to retain the conduit pipe principle many feared would disappear, and proposes to target interest-free loans made to trusts instead;
  • Further refinements to the harmonisation of the tax treatment of withdrawals from pension, provident and retirement annuity funds;
  • Repeal of the withholding tax on foreign service fees paid by SA tax residents;
  • As a result of the very complex and targeted anti-tax avoidance legislation linked to employee share incentive schemes, almost every year amendments are required to close new tax structures set up to reduce the tax consequences of these reward programmes as they relate to employees. This year is no different with certain targeted new anti-avoidance measures being proposed to the taxation of these schemes upon termination, as well as the taxation of dividends paid out on these shares throughout;
  • Significant amendments are introduced to the existing hybrid equity and debt instrument provisions in sections 8E to 8FA of the Income Tax Act, 1962. Most notably, the treatment of interest on subordinated debt as dividends for tax purposes have been addressed as relates to intra-group debt or cross-border debt issued to a South African tax resident;
  • Further relaxation of the rules as relates to venture capital companies are proposed to further entice taxpayers to make use of this very beneficial income tax incentive regime;
  • The Customs and Excise Act, 1964, is to have its own general anti-avoidance rules introduced as section 119B; and
  • A new understatement penalty category is proposed for a transaction to which the general anti-avoidance provisions in the Income Tax Act, 1962, or Value-Added Tax Act, 1991, are applied.

The public is invited to comment on the proposed changes by 8 August 2016. Please contact us should any of the above be of particular relevance to you and should it appear necessary to discuss these prior to these draft bills being passed by Parliament, very probably later this year.

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)

ASSET-FOR-SHARE TRANSACTIONS: TAX FREE RESTRUCTURE

A4_bThe Income Tax Act, 58 of 1962, contains several so-called ‘group relief’ provisions in terms whereof corporate restructures can take place on a tax neutral basis.  One of these is if a transaction comprises an ‘asset-for-share transaction’, or put simply:  where a company purchases an asset in exchange for which that company agrees to issue shares to the seller.

The term ‘group relief’ is somewhat of a misnomer in that not all of the group relief provisions necessarily involve groups of companies.  The ‘asset-for-share transaction’ is one such an example where company groups are not necessarily involved.  In fact, the concession (in section 42 of the Income Tax Act) is quite often used by individuals who are seeking to incorporate their businesses whereby they would transfer said business into a company in exchange for the latter issuing them with ordinary shares in that company.  Such a transaction would not give rise to any immediate income tax costs, nor to any ancillary taxes such as VAT, Securities Transfer Tax, Transfer Duty, etc. (on condition that the relevant required formalities are observed).

The effect of an ‘asset-for-share transaction’ is effectively that the cost of the assets transferred are ‘inherited’ by the company.  For example, assume Mr A has an asset with a base cost of R10 which is worth R100 today.  He is able to transfer that asset to the company in exchange for shares without incurring any tax liability, but the company will be deemed to have acquired that asset at R10, and likewise Mr A his shares at the same price.  The effect therefore is that when one day Mr A should sell his shares, or the company the asset, the capital gain on the original R10 cost would still be realised and consequently taxed at that stage.  The tax implications linked to the asset is therefore not avoided altogether, but merely postponed.

A few requirements to qualify for a section 42 transaction includes:

  • The person to whom the shares are issued (i.e. the person selling the asset) must hold a ‘qualifying interest’ in the company subsequent to the transaction being concluded (being most often at least a 10% interest held in the company);
  • The company and the person disposing of the asset must typically hold the asset with the same intent. In other words, if the company will hold the asset as trading stock, then so too must the person disposing thereof have held the asset as such; and
  • The asset must be worth more than its base cost at time of the transaction being concluded.

Admittedly, this may be quite complex.  To make matters worse, the provisions of section 42 apply automatically if its prerequisites are met and taxpayers are required to specifically elect out of its provisions if it does not want it to apply.  All the more reason why any restructure would be incomplete without a review by a tax expert first before implementation thereof.

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)