The impact of Section 7C on trusts

Introduction

The impact of Section 7C of the Income Tax Act 58 of 1962 on trusts w.r.t. loan accounts has become a complicated piece of legislation. It has created many headaches for trust founders and beneficiaries.   This section was introduced as an anti-avoidance measure to curb the avoidance of estate duty or donations tax. This section of the Act focuses specifically on where a connected person transferred growth assets to a trust. This is done by making use of an interest-free loan to the trust. Alternatively, where there are loans granted below the official rate of interest.

The tax considerations:

The impact of Section 7C is that a donation is deemed to have been made in these circumstances. The effect of this is that tax will therefore be calculated at 20% on the difference between the official rate of interest and the actual interest charged on the loan itself. The donation is deemed to be made on the last day of February which is the trust year-end date. The donations tax is payable by 31 March. 

One has to bear in mind that a natural person can choose to utilize the annual R100,000 exemption against a deemed donated amount. This could potentially lower the tax liability. This section was broadened to include companies where at least 20% of the shares or voting rights are held by trusts or by a beneficiary of a trust.

Therefore if a loan was made by a company to a trust and that trust owns 20% of the shares or voting rights, Section 7c  would also apply. Donations will be declared by completing an IT144 applicable to natural persons and the payment can be made through e-filing. 

When will the tax consequences not apply?

In terms of section 7C(5), the tax consequences of section 7C will not apply to the following trusts:

  • The trust is a Public Benefit Organisation;
  • If the trust is a vested trust as to receipts, accruals, and assets
  • The trust is a special trust as defined in paragraph (a) of special trust [see special trust]
  • If the trust used the proceeds from the loan to acquire a primary residence used by the lender or his spouse
  • Cross-border loans, which are not on an arm’s length basis as specified in terms of s31(1) (i.e. if the loan is subject to the transfer pricing provisions);
  • Loans which are sharia compliant financing arrangements [see s24JA];
  • Loans that are the subject of deemed dividends in terms of s64E(4)2; or
  • If the trust was created solely for an employee share incentive scheme.
Conclusion:

Utilizing a trust as a vehicle to house your investments takes careful planning and consideration as many unforeseen tax consequences may fall on trustees or beneficiaries.

TFB

If you need tax advice or assistance with trusts get in touch.

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