After a long period of uncertainty regarding what the legislator had in mind with regard to the taxation of trusts, the proposed tax law amendments were released for commentary last week.
Interest-free loans to trusts will remain free of donations tax and will continue to contribute to a reduction in estate duty but such loans will now be subject to income tax under the new section 7C of the Income Tax Act.
If the tax legislation amendment bill is accepted in its current form, it will be implemented with effect from 1 March 2017. It will however be applicable to all existing and future loans made to trusts. The new provisions will result in all loans made to trusts at an interest rate less than the “official rate of interest”to be treated differently. If a natural person, or company which is a connected person to such a natural person, makes a loan to a connected local or offshore trust, the difference in the interest rate incurred on such a loan (if any) and the official rate of interest will be included annually as deemed interest in the taxable income of the natural person who is directly or indirectly involved in the making of the loan to the trust.
The term “connected person” is defined in the Income Tax Act and refers to a company or trust in which a natural person enjoys a notable participation, interest or involvement. The term “official rate of interest” is also defined in the Act as the repurchase rate of the South African Reserve Bank plus 1% and for a rand-denominated loan this rate amounts to 8% per year since 1 April 2016. On a R1 million interest-free loan the deemed interest will amount to R80 000 per year which will result in tax due at the maximum rate of 41% of R32 800 per year.
The connected trust receiving the benefit of such a loan will only be able to deduct actual interest paid for income tax purposes. The deemed interest on which the lender is taxed cannot be used as a tax deduction by the trust. The natural person will also not be able to use the primary interest exemption against such deemed interest included in taxable income.
A natural person who had such deemed interest included in his or her taxable income will be able to claim back the resulting taxes paid from the relevant trust. However, if these taxes are not claimed back from the trust within three years, such amounts will be deemed to be a donation made by such person on which donations tax will be levied at 20%. A loan made by a natural person or a connected company to a connected trust will not qualify for the annual exemption from donations tax if such a loan is reduced by way of donation (the R100 000 annual exemption in the case of individuals and R10 000 in the case of companies).
The existing legislation contained in section 7 of the Income Tax Act, among others, was not recalled and it is unclear how these sections will interact with the new legislation. The draft legislation is not without its issues and there are several situations in which it is unclear what the effect of the new legislation will be. One hopes that all these issues are addressed prior to the promulgation of this new legislation.
Tenk (FH) Loubser is a director of TLA Wealth and Advisory Services. view profile>
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