Over the last year, the National Treasury has been keeping busy.
Some of the changes included amendments to legislation relating to trusts and donations tax. This was introduced in section 7C of the Income Tax Act. In this blog post, we run through the highlights to avoid stepping into a nasty tax snag.
THE STORY OF HOW SECTION 7C CAME TO BE
Odds are pretty good that every person reading this post is the trustee or beneficiary of some trust. Whether it’s your family trust or a trust created as an extension of your business: Usually, the sole motive for creating a trust is to avoid estate duty and donations tax.
In the past, this was definitely the first step in the right direction towards good tax planning. It’s important to ask yourself what will happen with your property when you pass away. This will have different tax consequences, so let’s have a look at the following scenarios:
Scenario #1:
If all assets are kept in your personal capacity, everything will be included in your deceased estate. The tax consequences will be as follows:
| VALUE OF ESTATE: | ESTATE DUTY PAYABLE: |
| R 0 – R 3,5 million | Exempt |
| R 3,5 million – R 30 million | 20% |
| R 30 million and above | 25% |
Scenario #2:
Should you transfer all property to a trust, this will trigger donations tax. There is however, an annual exemption is available which results in a more favorable effective tax rate:
| DONEE: | DONATIONS TAX PAYABLE: |
| Companies | (Total Donation – R 10 000 annual exemption ) x 20% |
| Natural persons | (Total Donation – R 100 000 annual exemption ) x 20% |
Note: Donations of R30 million and above are subject to donations tax of 25%.
Scenario #3:
Taxpayers found a way of avoiding donations tax. Instead of donating property to a trust, many individuals started transferring property to trusts through the use of low-interest or interest free loans.
And right there – is where SARS now wants their piece of the pie.
THE INTRODUCTION OF SECTION 7C
Section 7C is triggered when a loan is made by a natural person to a trust. Section 7C stipulates that any difference in the official interest rate and the interest rate charged on the loan – is seen as a deemed donation.
Deemed donation = (Official interest %) – (Interest % charged on the loan)
Example:
You transfer R2,8 million to your family trust subject to 0% interest. These funds are used to buy property as a nice little investment. The effect of section 7C is as follows:
| Deemed Donations | Donations Tax |
| = Official interest % – Interest % charged | = R280 000 – R100 000 |
| = 10% – 0% | = R180 000 x 20% |
| = R2 800 000 x 10% | = R36 000 |
| = R280 000 |
SARS CLOSES THE LOOPHOLES IN SECTION 7C
When a few savvy taxpayers found loopholes around section 7C, it didn’t take SARS long to introduce their anti-avoidance measures.
Loophole #1:
| Avoidance Scheme | Anti-Avoidance Rule |
| Instead of advancing a loan directly towards a trust, a natural person makes a loan to company that is owned by a trust. This didn’t trigger section 7C. | Section 7C now specifically includes loans made by a natural person (or by a company at the instance of a natural person) to a company, where the company to which the loan is made, is a connected person in relation to the trust. |
Loophole #2:
| Avoidance Scheme | Anti-Avoidance Rule |
| Taxpayers, who made a loan to a trust, transferred the claim of the loan to another natural person (e.g. their spouse). By transferring the loan claim, taxpayers argued that this breaks the link between the natural person who advanced the loan and the loan itself. | The trust will pay interest on the loan to the person who acquired that loan. A donation will arise in the hands of the person who acquired the loan to the extent that it pays interest on the loan at a rate lower than the official rate of interest. |
A FINAL WORD ON DONATIONS TAX
Keep in mind that SARS will treat the interest foregone as an ongoing annual donation by you at the end of each tax year. The donations tax will be payable by the end of March each year. SARS will use the supporting trust participants schedule on the ITR12T to identify loans that are subject section 7C.
The key take-away from section 7C is this: If tax planning was a good idea in the past – it’s become essential today. Our advice is to trust an expert in the field, especially when it can save you money.
Last year, Morgan Stanley made a blooper by giving out inaccurate tax advice to clients. But we have to admit, they did get one thing right on one of their advertisements:
“You must pay taxes. But there’s no law that says you got to leave a tip.”