On 19 January 2017 the Taxation Laws Amendment Act, No 16 of 2016 (2016 Amendment Act) came into effect. The 2016 Amendment Act introduced s7C into the Income Tax Act, No 58 of 1962 (Act) which provision will come into effect on 1 March 2017. Section 7C will bring about some important changes to the tax dispensation applicable to trusts.
Circumstances under which s7C will apply
From 1 March 2017 s7C will apply to any loan, advance or credit provided directly or indirectly to the trust by certain persons. The persons referred to are any natural person who is a connected person in relation to the trust or a company that is a connected person in relation to that natural person, ie a company in which that natural person, either individually or together with a connected person or persons, holds an interest of at least 20%.
Treatment of loans where s7C applies
In terms of s7C(2) no deduction, loss, allowance or capital loss may be claimed in respect of a disposal, including by way of a reduction or waiver, or in respect of the failure to claim payment of any loan, advance or credit referred to above. In terms of the Explanatory Memorandum to the Taxation Laws Amendment Bill 17B of 2016 (Explanatory Memorandum), this provision has been introduced to prevent persons from cancelling or waiving the loan, which had the effect of reducing the asset base of the lender for estate duty purposes.
Another anti-avoidance provision is s7C(3), which states that if a loan is made to the trust interest-free or at a rate lower than the official rate of interest as defined in paragraph 1 of the Seventh Schedule to the Act (Official Interest Rate) (the rate is currently 8%), an amount equal to the difference between the interest charged by the lender or holder of the loan and the Official Interest Rate will be treated as a donation made to the trust by the lender or holder of the loan. In terms of the Explanatory Memorandum, the interest forgone by the lender or holder of the loan will be treated as an ongoing and annual donation made to the trust on the last day of the trust’s year of assessment. Section 7C(4) deals with the situation where the advance, loan or credit was provided by a company at the instance of a shareholder who is a connected person in relation to that company.
Circumstances under which s7C will not apply
Section 7C(2) and s7C(3) of the Act will not apply under the following circumstances:
- where the trust is an approved public benefit organisation in terms of s30(3) of the Act or a small business funding entity approved by the Commissioner in terms of s30C of the Act;
- in the case of a vesting trust (bewind trust), where the loan is made by a trust beneficiary to a vesting trust, provided that the four requirements of s7C(5)(b) are met;
- if the trust is a special trust created solely for the benefit of minors with a disability as defined in paragraph (a) of the definition of “special trust” in s1 of the Act;
- where the loan, advance or credit constitutes an affected transaction as defined in s31(1) of the Act (which deals with transfer pricing);
- where the loan, advance or credit was provided to that trust in terms of an arrangement that would have qualified as a sharia compliant financing arrangement as contemplated in s24JA of the Act, had the trust been a bank as defined in that section;
- if the loan, advance or credit is subject to the anti-value extraction provisions of s64E(4) of the Act; and
- where the trust used that loan, advance or credit wholly or partly to fund the acquisition of a residence that is used by that person or their spouse as their primary residence, to the extent to which that loan, advance or credit was used to fund the acquisition.
Where s7C applies to a loan provided to the trust, from 1 March 2017 the trust will incur interest on any amounts still outstanding on loan account, in terms of s7C(3) of the Act.
With regard to newly established trusts, where s7C applies a person may only donate R100,000 to the trust in any specific year of assessment. Any amount donated in excess of this will be subject to donations tax. However, this amount will not be owed on loan account and no interest will be incurred by the trust.