Another tax loophole is about to close with new rules for loans to trusts
02 August 2016
Posted by: Author: Amanda Visser
Author: Amanda Visser (BDlive)
National Treasury wants to put the brakes on some aggressive tax planning through trusts.
Trusts and their perceived use to transfer wealth without paying either donations tax or estate duty have for many years been a thorn in the side of the South African Revenue Service (SARS).
The latest proposed change to the Income Tax Act targets the use of interest-free or low-interest loans made to trusts without attracting either donations tax or estate duty.
Hanneke Farrand, tax director at law firm ENSafrica, says the proposed provision in the Draft Taxation Laws Amendment Bill would apply, for example, to a loan made to a trust by any individual who is a beneficiary of that trust or whose relative is a beneficiary of the trust.
It would also apply to a loan made to a trust by a company in which that individual holds more than 20% of the equity shares or voting rights.
Graham Crocker, tax associate at law firm Bowman Gilfillan, says interest-free loans to a local trust have commonly been used to enable the trust to fund assets, and then to write off the loan in annual R100,000 increments (the annual donations tax exemption amount).
The new proposal aims to put a stop to that.
Crocker says if one makes a loan to a normal family trust and the interest rate on the loan is less than the official rate (currently 8%), the lender will in future be subject to income tax on the deemed interest.
The deemed interest is the difference between the amount of interest actually charged and the official rate of interest.
In addition, the taxpayer who made the loan will not qualify for the normal tax exemption for interest (currently R23,800 for individuals younger than 65) on this deemed amount.
The taxpayer will also have to recover this tax liability from the trust within three years, or else it will be considered a donation, triggering donations tax on the amount.
Farrand says that in terms of the proposed measure, the annual donations tax exemption of R100,000 will not apply to any amount used to pay off the loan, credit or advance allowance made to the trust.
She says the proposed amendments are expected to come into operation on March 1 2017 and will apply to years of assessment starting on or after that date.
"These proposals will, accordingly, apply to loans in existence at that date, which meet the requirements of the new provision, as well as to any subsequent loans," she warns.
Piet Nel, head of tax technical at the South African Institute of Tax Professionals (SAIT), says the draft is actually not totally clear on this aspect.
The relevant section uses the words "makes or provides any loan", but then in announcing the effective date, it does not clarify that it applies only to loans made on or after March 1 2017.
Farrand says there has been uncertainty regarding changes to the tax treatment of trusts and estates since the Davis Tax Committee’s first report on estate duty was released last year. These proposals give some clarification on the tax changes.
Dan Foster, tax director at Webber Wentzel, says the Davis committee’s interim report on estate duty is still with the finance minister for review, but the minister promised some changes this year already.
"It is important to note that the more punitive measure proposed in the budget, namely that assets acquired by a trust with interest-free loan funding would be added back to the dutiable estate of the lender at his death, have not been proposed in the draft bill," says Foster.
Louis van Vuren, CEO of the Fiduciary Institute of SA, says if these more punitive measures were introduced on top of the proposed new section 7C, it would have amounted to taxing the same amount twice.
The two measures were most probably always seen as alternative methods to attain the same aim, namely to help Treasury prevent the use of interest-free loans to transfer assets to trusts with no tax charge, Van Vuren says.
SAIT says one of its main concerns is that the proposal does not seem to recognise that other specific anti-avoidance measures may also apply to the same interest-free loan.
Crocker says there are ways for taxpayers to minimise the punitive effects of the proposed new section, assuming it is introduced in its current form.
He says taxpayers can donate their annual R100,000 in cash, rather than donating by writing off loans that would not qualify for donations tax exemption.
"If you are not already using the annual interest exemption amount, charge interest at the official rate of interest (currently 8%) and claim this exemption (R23,800), rather than being taxed on deemed income that would not qualify for any exemption," he says in an article.
PwC says in its latest Tax Alert that trusts remain an effective, flexible and valuable tool that can be used for a variety of purposes.
This includes not only estate planning, but also safeguarding wealth, affording protection against creditors, and comprehensive family wealth planning.
Tax professionals point out that the proposals are still in draft form at this stage and the legislation has not yet been promulgated. Stakeholders have until August 8 to give their views on the proposed changes.
This article first appeared on bdlive.co.za.