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)

SO WHAT IS THE FUTURE OF TRUSTS?

A1_bOne of the questions that we are most confronted with by our clients is what the future of trusts are in South Africa.  Some questions even point to the misconception that the trust instrument itself as legal form is on the verge of being scrapped in South Africa altogether!

The current debate raging is not at all that dramatic, although the consequences for taxpayers potentially may be.  The “crystal ball” gazing exercise which we are so often requested to undertake stems from repeated warnings (some less subtle than other) by the Minister of Finance that the use of trusts as a tool to minimise tax exposure, be it in the form of income tax or estate duty, is being revisited by National Treasury to try and find a solution to the perceived abuse thereof.  As recently as in the 2016 budget, the following statement is made:

“Some taxpayers use trusts to avoid paying estate duty and donations tax. For example, if the founder of a trust sells his or her assets to the trust, and grants the trust an interest-free loan as payment, donations tax is not triggered and the assets are not included in his or her estate at death. To limit taxpayers’ ability to transfer wealth without being taxed, government proposes to ensure that the assets transferred through a loan to a trust are included in the estate of the founder at death, and to categorise interest-free loans to trusts as donations. Further measures to limit the use of discretionary trusts for income-splitting and other tax benefits will also be considered.”

This alludes both to how trusts are commonly used to minimise tax obligations, as well as how Treasury intends to (what could be considered a more focused) approach to trusts in future, while also hinting at what may be expected going forward.

As a first comment, trusts are popular estate duty planning instruments.  Without going into too much detail, typically an individual will sell his/her assets to a trust on interest free loan account.  In the coming years, the value of the assets will increase in the trust, while the value of the loan account will remain the same in the hands of the individual.

Secondly, trusts are potentially useful for income tax planning purposes as they allow for income to be distributed to individuals that are subject to tax at rates more beneficial than that of the trust (which involves ‘income-splitting’ referred to by Treasury above).  Typically these distributions often contains a fictitious element through distributions made on interest free loan account only (with no real intention that such distributions should vest in the beneficiaries).

It would appear as though Treasury is no longer considering an ‘out-and-out’ onslaught on the taxation of trusts (although this is only speculation).  However, the recent budget perhaps betrays what may be expected and that anti-avoidance legislation is to be introduced that will focus only on abusive practices involving trusts.  For both estate duty and income tax structures involving trusts, it is not farfetched to expect to see provisions introduced into tax legislation which will ensure that loan accounts with trusts all bear interest.  The significance of this?  Interest receipts are subject to income tax.

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)