INTEREST-FREE LOANS TO A TRUST TRIGGER DONATIONS TAX

DO YOU use a trust as a financial planning tool for you and your family? If your answer is yes, you might want to read this carefully.

In terms of section 7C of the Income Tax Act, the interest-free portion of a loan provided to a trust is deemed to be a donation, and thus subject to 20 percent donations tax, paid by the donor.

This provision came into effect on March 1, 2018.

It states that any natural person who is connected to a trust, and who makes a loan to a trust and does not charge market-related interest on that loan, will be deemed to have donated that interest-free portion of the loan to the trust, thus triggering a donations tax liability.

For example, on July 5, 2018, you make an interest-free loan of R2.5 million to a trust, of which you are a beneficiary. You do not charge any interest on this loan to the trust.

Assume the market-related interest rate is 7.5 percent a year, as stated on the interest rate tables of the South African Revenue Service (Sars).

The interest-free portion of the loan is R187 500 (R2.5m x

7.5 percent) a year. Thus, it is deemed that you donate R187 500 to the trust each year, provided that the capital portion of the loan remains the same.

The annual general exemption from donations tax is R100 000. The amount that is subject to donations tax is therefore R87 500.

You will be liable for donations tax of 20 percent on the R87 500, which is R17 500 a year.

The aim of the new provision is to prevent taxpayers from reducing their estate duty liability, by granting loans to trusts.

The legislation includes the words “directly or indirectly”, which means that if a person connected to a trust in any manner or form makes a loan to a trust, there will be donations tax consequences, and a company is exposed to dividends tax as a result of the deemed dividend rules.

For example, if a beneficiary of a trust is also a 35 percent shareholder of a company that is not connected to the trust, and that company, at the beneficiary’s insistence, provides a loan to the trust, it is deemed that the beneficiary made a loan to the trust and any interest-free portion will be treated as a donation made by the beneficiary, which will trigger donations tax.

There are general and specific exemptions from donations tax. The annual general exemption is R100 000 for a natural person and R10 000 for a company.

A specific exemption from section 7C is if the trust is a qualifying public benefit organisation, or if the trust is a vesting trust or a special trust.

Another exemption is if a taxpayer grants a loan to a trust to wholly or partly fund the acquisition of his or her primary residence.

Section 7C has led to a plethora of restructuring arrangements where taxpayers try to get out of the trust structure with loan accounts to the trusts.

However, be aware of the Sars anti-avoidance arrangements that can deem any restructuring transactions to be void if such transactions are found to be done purely to avoid tax.

As with all other planning transactions, it is important to consider all aspects of the transaction and whether or not it makes sound commercial sense. Remember, don’t let the tax tail wag the dog.

So, next time you want to use your trust as a tax-planning tool, think twice before this provision sends you off to sail the seven seas into an unwanted tax debt.