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South Africa to charge tax on interest-free loans to trusts

Thursday, 4 August, 2016

South Africa's draft Taxation Laws Amendment Bill 2016 includes measures to prevent avoidance of estate duty and donations tax through the transfer of assets to a trust on an interest-free loan account.

It has been common practice for family members to sell assets to their trust on loan account at an interest rate below the arm's length rate – often, in fact, at zero interest. Traditionally, such loans have resulted in a reduction of estate duty while also avoiding the donations tax.

The transferor could then reduce the loan capital by donating modest amounts to the trust to be offset against the loan using the current provisions of s56(2)(b) of the Income Tax Act which provides for exemption from donations tax on annual donations of up to ZAR100,000. ‘The fact that no interest is paid by the Trust means that the transferor is also not exposed to tax on income that would otherwise have arisen in his hands, unless the attribution rules referred to above apply’ says accountancy firm Grant Thornton.

Section 7C of the proposed new rules provides that an interest-free loan received by the trust from a 'connected' person will be deemed to have been made at the market interest rate, and be taxable in the hands of the lender. Moreover, the amount deemed to be income for the lender will not qualify for the usual interest exemption, and the deemed interest will not be tax-deductible in the hands of the trust.

The section applies where the loan is advanced by any natural person, or a company in relation to which that person is a connected person, typically someone who holds at least 20 per cent of the equity share capital.

The lender is prohibited from claiming any capital loss arising as a result of the reduction or waiver of or failure on the part of the trust to repay the debt.

The lender can recover the tax paid on the deemed income from the trust, but if any of the tax payable by the lender is not recovered from the trust within three years, it will be treated as a donation to the trust and taxed at the donations rate of 20 per cent.

The new section is still in draft form and might change before the final act is promulgated. Grant Thornton says, however, that it does not expect any drastic changes. 'Fortunately, the proposed amendments will apply only in respect of years of assessment commencing on or after 1 March 2017', said the firm. There is therefore still some limited time for families to make changes to their current structures.

  • South Africa's National Treasury has also announced a simplification to the Special Voluntary Disclosure Programme (SVDP) that starts on 1 October. Taxpayers will have to trace their untaxed offshore assets going back five years.

Sources