In an attempt to curb the avoidance of estate duty and donations tax National Treasury introduced Section 7C of the Income Tax Act with effect from 1 March 2017. This anti-avoidance section focuses on natural persons who have transferred growth assets (tax free) to a trust through the use of an interest free loan or a loan with interest below market rates.
Section 7C applies where a natural person (or a company at the instance of that natural person) has made a loan to a local or foreign trust that does not attract interest at least equal to the SARS official rate of interest (currently 7.75% per annum for a Rand-denominated loan; for foreign currency loans the rate is the equivalent of the SA repo rate applicable in that currency plus 1%). For Section 7C to apply, the lender and the trust need to be connected persons. This would typically be the case where the lender is a beneficiary of the trust, or a person connected to the lender (e.g. a relative) is a beneficiary of the trust.
Should Section 7C apply, the lender is deemed to have made a donation on the last day of the tax year (i.e. 28 February 2018 for the first time) amounting to the difference between the interest that would have been charged and the interest actually charged. Assuming a R10 million interest-free loan to a trust by a natural person connected to the trust, outstanding for the entire tax year, with no change in the official rate of interest and no fluctuation in the loan balance, the lender would be deemed to have made a donation amounting to R775,000 on 28 February. Assuming the natural person has not yet utilised their R100,000 annual donations tax exemption, the donation tax payable in this regard would amount to R135,000 (R675,000 at a donations tax rate of 20%). Note that as donations tax only applies to SA tax residents, Section 7C does not apply to non-resident lenders to SA trusts.
With effect from 19 July 2017, the scope of Section 7C was widened to include low interest loans to companies where at least 20% of that company’s equity shares or voting rights are held by a trust connected to the lender. The scope was also widened to include the scenario where a person acquires a loan claim from another person where that loan was subject to Section 7C.
Calculation of donations tax
As was highlighted in a tax alert article published by the South African Institute of Chartered Accountants (SAICA) on 1 March 2018 Section 7C of the Act does not expressly prescribe the calculation methodology of the deemed donation. Section 7C only prescribes the rate that needs to be used to determine the deemed amount of interest during the year of assessment.
SAICA pointed out that it is the South African Revenue Services (SARS) practice as far as it relates to dividend withholding tax, which also does not have a calculation methodology, seems to be the daily simple interest on the daily balance outstanding. Accordingly, if the capital amount of the outstanding loan changes during the year of assessment, it should be taken into consideration in the calculation.
Importance on vesting clauses in Trust Deeds.
SARS published an explanatory memorandum on 15 December 2016. In the memorandum, it explains the thinking and reasoning of SARS pertaining to loans created by way of vesting rights to a beneficiary but such right has not been distributed to the beneficiary:
“The proposed rules will apply only in respect of loans advanced or provided by a natural person or, at that person’s instance, by a connected company. An amount that is vested irrevocably by a trustee in a trust beneficiary and that is used or administered for the benefit of that beneficiary without distributing or paying it to that beneficiary will not qualify as a loan or credit provided by that beneficiary to that trust if:
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the vested amount may in terms of the trust deed governing that trust not be distributed to that beneficiary, e.g. before that beneficiary reaches a specific age; or
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that trustee has the sole discretion in terms of that trust deed regarding the timing of and the extent of any distribution to that beneficiary of such vested amount.
An amount vested by a trust in a trust beneficiary that is not distributed to that beneficiary will, however, qualify as a loan or credit provided by that beneficiary to that trust if that non-distribution results from an election exercised by that beneficiary or a request by that beneficiary that the amount not be distributed or paid over, e.g. if the beneficiary has reached the age at which a vested amount must be paid over or distributed to him or her and:
It is clear from the above excerpt that careful consideration should be made when dealing with vesting rights in a Trust. Clearly, if so exercised by a beneficiary, a loan to the value of the undistributed amount will be made by the beneficiary to the Trust and interest should be charged at the official rate of interest to avoid any deemed donation by the beneficiary.
Budget proposals
The recently delivered National Budget on 21 February 2018 contained further potentially negative news in relation to Section 7C, with the donations tax rate increased to 25% for donations exceeding R30 million, and a proposal to increase the official rate of interest (currently 7.75%) to a rate closer to the prime lending rate (interest charged by banks to their clients – currently 10.25%).
Exemptions
Section 7C(5) provides that no donations tax will arise in respect of loans or advances where:
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the trust is a public benefit organisation approved by the Commissioner under section 30(3) of the Act or a small business funding entity approved by the Commissioner under section 30C;
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the trust is a special trust as defined in paragraph (a) of the definition of ‘special trust’;
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the trust used the loan wholly or partly for purposes of funding the acquisition of an asset and the natural person or their spouse used that asset as a primary residence as envisaged in the definition of primary residence in the Eighth Schedule to the Act and the amount owed relates to the part of that loan that funded the acquisition of that residence;
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that loan or advance was provided to that trust in terms of an arrangement that would have been regarded as a sharia compliant financing arrangement as referred to in section 24JA of the Act;
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that loan or advance is subject to the provisions of section 64E(4) relating to deemed dividends under the dividends tax rules;
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that loan or advance comprises an affected transaction as referred to in section 31(1) of the Act which is subject to the provisions of that section; or
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that loan or advance was provided to that trust by a person as a result of the vested interest held by that person in the receipts and accruals of the assets of that trust and the conditions specified in section 7C(5)(b) are complied with.
Payment of donations tax and IT144 return submission
Given that the deemed donation occurs on 28 February and that donations tax is payable on the last day of the month immediately after the month in which the donation was made (i.e. by 31 March in this instance), various practical concerns have been raised by industry. Among these that this leaves little time for taxpayers to correctly calculate their donations tax liability, make the related payment to SARS and submit the donations tax IT144 form.
This is further exacerbated due to limitations in SARS’ eFiling system regarding donations tax submissions and payments. A practical issue is that donations tax payments cannot be made via electronic banking as there is no way of the taxpayer allocation a PRN reference number and beneficiary ID to the payment. The donations tax payment can ONLY be made via eFiling using the credit push option. The donations tax payment will therefore be initiated on eFiling, but only processed once the payer provides the necessary authorisation through their internet banking profile.
A further complication is that in terms of section 60(4) of the Act an IT144 form must accompany the donations tax payment. The IT144 form can only be manually submitted to a SARS Branch thus the taxpayer must attach the proof of payment of the donations tax with the IT144 form and ensure the SARS Branch acknowledges receipt of the form.
SARS recently confirmed that they do not consider the donations tax declaration process to be onerous and expect the donations tax on Section 7C deemed donations to be paid by 29 March 2018 (30 March is a Public Holiday & 31 March is a Saturday), although extensions may be granted on a case-by-case basis.
Failure to declare and pay the donations tax could result in the imposition of fixed amount penalties for the non-submission of a tax return, understatement penalties and the incurral of late payment interest.
It is recommended that lenders to which Section 7C applies, or to which Section 7C may apply, consult a tax professional for advice in this regard and assistance regarding the submission and payment of the related donations tax.