HOW WILL THE CHANGES AFFECT YOUR TRUSTS?
The Draft Taxation Laws Amendment Bill, due to come into effect on March 2017, proposes to radically affect the manner in which individuals and entities have used trusts to avoid certain tax consequences. The time is approaching to reconsider our use of trusts and make the necessary arrangements prior to the Bill being passed into law.
By Amy Farish (Candidate Attorney at Hayes Incorporated)
For many years, trusts have been used as estate planning vehicles by individuals who wish to avoid certain tax consequences, specifically estate duty and donations tax. Trusts assisted in the sense that an individual could reduce his estate value by transferring assets to a trust, generally against an interest free loan or a loan with interest charged below market rates, and thereby decrease the value of his estate avoiding excessive estate duty charges. Due to interest not being levied or being levied at a rate below market value, the lender does not incur any income tax obligations. The lender does not have to pay donations tax as the asset is transferred at market value and, furthermore, the individual could donate to the trust annually to reduce the outstanding loan amount and incur no tax consequences due to the R100,000 annual exemption from donations tax.
On 8 July 2016, the Minister of Finance published the Draft Taxation Laws Amendment Bill which amends various laws relating to tax liability and includes provisions limiting the benefits that trusts had previously provided to individuals.
Section 7C of the Income Tax Act proposes to limit the benefits that had previously been available by introducing a clause that provides for the following –
- the lender/seller, which is a related person or entity to the trust, shall not be able to transfer assets on loan with no interest or interest below market value as the difference between the interest charged and the official rate of interest (being the South African repo rate plus 1%, currently 8%) shall form part of the lender/seller’s income and therefore be subject to income tax;
- the exemption found in section 10(1)(i) of the Income Tax Act, being an exemption in respect of interest earned from loans granted by individuals, shall not be applicable to loans to trusts;
- donations made to trusts shall no longer qualify for the exemption of R100,000 for each year of assessment found in section 56(2)(b) of the Income Tax Act; and
- the seller/lender will have to claim the amount equal to its income tax charged in respect of the interest accruing in favour of the seller/lender from the trust as the trust has benefitted from the non-payment of interest. If such claim is not instituted within 3 years after the year of assessment in which the interest was included in the seller/lender’s income, the amount of the claim will be considered a donation and donations tax will be charged to the seller/lender.
The above amendments are due to come into force on 1 March 2017 and will be applicable to the years of assessment following this date. Once / if the Draft Bill is made law, a review of all existing Trust structures with interest free loans or loans with interest rates below the official rate of interest will be required in order to sanction such agreements and determine and implement a plan for regulation going forward.
If your trust is party to such transactions, it will be necessary, if the Draft Bill is promulgated, to revise the terms of the loan and ensure that it is compliant with the new laws i.e. the interest rate will need to be at least 8% and if it is not the difference between the interest levied and the official rate of interest will be “deemed interest” and form part of the income of the lender/seller. To avoid the recurring payments of income tax by the lender/ seller, the lender/seller can donate the asset to the trust and incur the once off 20% donations tax. Alternatively, the trust may repay the loan in full if the trust has the means or it may sell assets to obtain the means so long as the capital gains tax that may be levied, for selling the asset for an amount that is more than the amount for which the asset was purchased, does not defeat the object of repaying the loan.
In the case of your trust being subject to the above implications of the new laws, and due to there being various avenues available to trustees to minimise the negative effects of the legislation, we recommend receiving tax advice on how to proceed in managing your trusts’ assets prior to the commencement date of the legislation coming into force if the Bill is passed in Parliament.