The aim of this article is to alert individuals to donations tax considerations over and above the utilisation of the full R100,000 annual exemption which will inevitably be used to a great degree now that section 7C has been introduced.
With the spotlight on trusts and certain interest free loans to trusts attracting donations tax (through section 7C of the income tax act), I thought it fitting to write about donations in general, including specific considerations regarding donations tax and how it may become increasingly important to monitor the nature of transactions entered into by individuals in order to determine whether a donation has been made.
Within the constantly changing environment of tax law (the budget speech of 22 February 2017 being a good example of significant and sudden changes) it is important to revisit existing legislation and principles in order to ensure that tax planning under new and/or amended laws and regulations does not cause anomalies in other areas.
Compliance with section 7C (explained below) may result in significant donations (deemed) being made during a year of assessment. These need to be considered along with all other donations that are already being made annually, some of which individuals may not even be aware that they are making.
Definition and history
A donation is any gratuitous disposal of property or any gratuitous waiver or renunciation of a right.
Donations tax is a tax on the transfer of wealth from one person to another. It was first introduced in 1955 when the Estate Duty Act was promulgated. The logic behind introducing the two mechanisms at the same time is that, if a person were to attempt to avoid Estate Duty by donating their assets, donations tax would be triggered.
Section 7C of the Income Tax Act came into effect on 1 March 2017. The section provides that if a natural person makes a loan to a trust to which he or she is connected (for example by being a beneficiary), a donation will arise in the hands of the person making the loan if no interest is charged, or interest is charged at a rate that is lower than the “official rate” of interest as prescribed by SARS. The donation will be equivalent to the difference between the amount of interest charged (if any) and the interest as calculated using the SARS “official rate”, currently 8% per annum.
One of the ways to overcome the above, or reduce the donations tax, is to utilise the annual donations tax exemption of R100,000. This being that donations tax is not payable on the sum of all assets donated by a natural person during a year of assessment as does not exceed R100,000. Working backwards from R100,000 to the above section 7C interest on loans, this effectively means that a loan to the value of R1,250,000 will not attract donations tax if no interest is charged (8% of R1,250,000 being R100,000), assuming the full R100,000 exemption is utilised.
The danger with the above mechanism is that, should a natural person elect to utilise the full R100,000 annual exemption on an interest free loan to a trust, then that natural person can make no other donations whatsoever during the year of assessment.
Donations of R100,000 plus R1
A common mechanism historically used in trusts is for loans made by beneficiaries to the trusts to be reduced annually by R100,000. This is through making use of the R100,000 annual exemption for donations tax. It should be noted that there must be an actual flow of cash as a donation instead of merely an accounting entry.
It is important to realise then that if an interest free loan is owing by the trust to a connected person to the trust, the above R100,000 reduction in the loan can no longer be applied to the extent that part or all of the R100,000 is to be used to counter the deemed annual donation of interest not being charged.
Making use of either of the aforementioned mechanisms creates a situation whereby that individual is utilising the full R100,000 annual exemption against the reduction in the loan or to counter the effects of the donation arising from not charging interest, thereby leaving no exemption for any other donations during the year of assessment.
It is therefore important that individuals consider all other donations made during a year of assessment before simply utilising the entire R100,000 annual exemption on a single transaction.
Common exemptions and common donations
Common exemptions from donations tax include:
- Donations to a spouse
- Donations to approved tax-exempt Public Benefit Organisations (PBOs)
- Contributions to the maintenance of an individual
Here are some considerations regarding common “transactions” that would be considered donations:
- Gifts to children and family members
- Gifts or aid to disadvantaged individuals or the poor (other than through PBOs as above)
- Gifts to certain institutions (other than for services) for example charitable institutions not registered as PBOs
It is also important to consider the fact that the waiver of a right to something also falls within the definition of a donation. Therefore, if a loan is due and payable to an individual and that individual chooses to waive the right to that loan, the waiver of the right will attract donations tax.
As mentioned, it is important to take into consideration the above type scenarios when determining to use the entire annual exemption of R100,000, or even a substantial portion thereof since all other donations over and above R100,000 would then attract donations tax.
For the sake of clarity, donations tax is payable at the rate of 20% of the value of the asset or amount of money donated, payable by the donor. The donations tax must be paid by the end of the month following that in which the donation was made. It should be noted that if the donor fails to pay the donations tax, the donor and the donee then become jointly and severally liable for the tax.
Donations as deductions from taxable income
As an aside, there is a common misconception that all donations made to public benefit organisations are tax deductible. As mentioned above, donations to tax-exempt public benefit organisations are exempt from donations tax. This does not however automatically entitle the donors to deduct such amounts from income for income tax purposes. Such deductions are only allowed if the donation is made to a section 18A approved public benefit organisation which is able to issue the donor with a section 18A compliant certificate/receipt. The scope for registration with SARS as a section 18A approved organisation is far narrower than the “general” registration as a public benefit organisation.
Challenging times ahead
There is a significant challenge ahead for taxpayers who are attempting to protect their wealth for retirement or for future generations. As can be seen from above, donations tax is a mechanism designed to ensure Estate Duty is not evaded. By changing income tax legislation to include a tax on interest not charged on loans made to a trust any number of years ago, the effect is a retrospective application of a current change, in many cases undoing years of honest financial planning. The challenge is to revisit structures and make changes where possible in order to ensure compliance with tax law as well as preserving the planned future effects of financial planning made any number of years ago.
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.