Heads up Trusts: Section 7C Has Arrived!


Many of us, especially those who have a significant number of assets and want some form of protection, have created Trusts over the years to benefit and administer our estates in such a way to minimise risk and as a consequence of common law and legislation, draw on the tax benefit it offers.
 
At the beginning of the year, the presidency signed into law the Taxation Laws Amendment Act, No. 15 of 2016, noted in the government gazette number 40562 on 19 January 2017 (the “Act”) which will change estate planning and how trusts are used.
 
Background
 
Most donors choose to sell or donate property to their Trusts for tax planning purposes. Donating property is far less beneficial nowadays because tax laws only allow for a R100 000 donation tax exemption when a person donates an asset to a Trust and also, the donation is taxed at 20% of the value of the donation. Generally, this method is too expensive. As another option, a person can sell the asset to a Trust on loan. Subsequently, the Trust will record a loan in favour of the seller and the loan will be subject to no interest or, at most, a below market interest rate. The effect being that the Trust should pay market related interest, resulting in income in the hands of the seller, who would have included such amount in it/his/her taxable income for the year of assessment. However, if structured that the seller will pay little to no interest in some cases, that portion of personal income is reduced and less personal tax is payable. From a South African Revenue Service and ultimately the Department of Treasury’s point of view, it is an important source of income for them.
 
In the Act, section 7C specifically address the issue whereby a loan, credit or an advance is granted to a Trust at no interest or below market related interest rates. The section is structured in such a way that it allows for no recoupment on losses or the deduction of expenses actually incurred and as a result it deems the difference in interest rates (actual rate versus the official rate of interest per Schedule 7 of the Income Tax Act) as a donation to the Trust. In summary, section 7C is an anti-avoidance mechanism other than being a guideline when dealing with loans to Truts.
 
The Basics
 
Application
 
The section applies to any loan, credit or advance granted directly or indirectly to a Trust by any natural person or a company in relation to whom that natural person or the company is a connected party too.
 
Restriction
 
No deduction, loss, allowance or capital loss on that loan, credit or advance may be claimed by a person in respect of the interest free or low interest loan made to the Trust.
 
Adjustment
 
If a Trust, as a result of the loan, credit or advance, does not incur interest or if the interest that is charged is lower than the official rate of interest contained in Schedule 7 of the Income Tax Act, an amount equal to the difference between the interest rate charged and what the official rate of interest is, must be treated as a donation to the Trust by that person for that year of assessment.
 
Multiple Lenders
 
If a loan, credit or advance was provided by a company to a Trust at the instance of more than one person that is a connected person in relation to that company; an amount equal to the difference between the interest rate charged and what the official rate of interest is, must be treated as a donation by the Shareholders of the company in their respective shareholding ratios. This rule will not apply if the loan is subjected to Dividend Tax. 
 
Exclusions
 
Certain Trusts are excluded from the ambit of section 7C. There are also other exclusions which will apply, for instance, vesting clauses in a Trust Deed which vesting clauses are irrevocable by a Trustee or if the loan was advanced to the Trust to acquire a primary residence for their spouse and the residence was used by that spouse throughout that year of assessment.
 
Date of application
 
Section 7C applies from 01 March 2017 on all loans, credit or advances before, on or after the date.
 
Importance on vesting clauses in Trust Deeds.
 
SARS published an explanatory memorandum on 15 December 2016. In the memorandum, it explains the thinking and reasoning of SARS pertaining to loans created by way of vesting rights to a beneficiary but such right has not been distributed to the beneficiary:
 
The proposed rules will apply only in respect of loans advanced or provided by a natural person or, at that person’s instance, by a connected company. An amount that is vested irrevocably by a trustee in a trust beneficiary and that is used or administered for the benefit of that beneficiary without distributing or paying it to that beneficiary will not qualify as a loan or credit provided by that beneficiary to that trust if:
 
  • the vested amount may in terms of the trust deed governing that trust not be distributed to that beneficiary, e.g. before that beneficiary reaches a specific age; or
  • that trustee has the sole discretion in terms of that trust deed regarding the timing of and the extent of any distribution to that beneficiary of such vested amount.
An amount vested by a trust in a trust beneficiary that is not distributed to that beneficiary will, however, qualify as a loan or credit provided by that beneficiary to that trust if that non-distribution results from an election exercised by that beneficiary or a request by that beneficiary that the amount not be distributed or paid over, e.g. if the beneficiary has reached the age at which a vested amount must be paid over or distributed to him or her and:
 
  • the trustee accedes to a request by that beneficiary that this not be done; or
  • the beneficiary enters into an agreement with the trustee in terms of which the amount may be retained in the trust.
It is clear from the above excerpt that careful consideration should be made when dealing with vesting rights in a Trust. Clearly, if so exercised by a beneficiary, a loan to the value of the undistributed amount will be made by the beneficiary to the Trust and interest should be charged at the official rate of interest to avoid any deemed donation by the beneficiary.
 
Conclusion
 
Section 7C will most likely impact on the way donors and Trustees approach estate planning. There will be definite complications with Trust administration if not done in accordance with this new anti-avoidance provision of the Act.