New tax provisions, set out in section 7C of the Income Tax Act, 1962 (“Act”), relating to interest-free or low-interest loans to trusts come into effect on 1 March 2017.
The new law applies to any loan, advance or credit (“loan”) made to a trust by:
- a natural person, or
- at the instance of that person, a company in relation to which that person is a connected person (i.e. holds directly or indirectly at least 20% of the shares in the company).
If there is no interest levied on the loan to the trust or the interest rate is lower than the official rate of interest (currently 8%) the loan may be subject to the new law. This will require the person to treat as a donation made to the trust, the difference between the interest incurred by the trust and the amount that would have been incurred had the official rate of interest been charged.
The donation will have been deemed to have been made on the last day of the year of assessment of the trust. The lender will, therefore, be liable for donations tax at a rate of 20% on the donation on such date. However, the lender will be able to deduct from the donation the annual exemption amount, which is currently R100 000. Therefore, assuming a natural person has made no other use of this exemption, only loans in excess of R1 250 000 will trigger the tax.
By way of an example, Mr X lends R2 million at 0% interest to a trust to buy shares. Interest that would have been incurred had the official rate applied at 8% is R160 000. Less the annual exemption of R100 000, leaves a R60 000 donation subject to tax at 20%.
There are a number of exclusions to which the new provisions will not apply, which include, where:
- the trust is an approved public benefit organisation;
- the loan was made by a person by reason of, or in return for, a vested interest held by that person in the trust;
- the trust is a special trust;
- the loan was used to acquire the lender or his spouse’s primary residence;
- the loan is subject to the transfer pricing provisions in section 31 of the Act;
- the loan would have qualified as a sharia compliant financing arrangement;
- the loan is subject to the deemed dividend provisions in section 64E(4) of the Act.
This article has been written by Graeme Palmer, a Director in the Commercial Department of Garlicke & Bousfield Inc
For more information contact Lizette Martins, details below.
NOTE: This information should not be regarded as legal advice and is merely provided for information purposes on various aspects of tax law.