Some of us might be aware that the section 7C of the Income Tax Act No. 58 of 1962 (the Act) originally came into effect on 1 March 2017, but it is important to note that on 19 July 2017, the provisions of Section 7C were extended to include a loan made by an individual to a company in which such a Trust holds at least 20% of the equity shares or is able to exercise 20% of the voting rights.
In the past it was common practice for a trust to obtain assets by way of an interest-free or low interest loan from a natural person. The objective of section 7C is to tax qualifying loans issued by related parties (founder, beneficiaries etc.) to trusts, if these loans attract interest at a rate lower than the official rate of interest (currently 7.75 %).
What does section 7C seek to address?
Simply put, Section 7C is an anti-avoidance provision designed to address a situation where a loan is made to a qualifying borrower interest-free or at a rate lower than the official rate of interest as defined in paragraph 1 of the Seventh Schedule to the Act (Official Interest Rate).
What are the tax implications of section 7C?
An amount, calculated as the difference between the interest charged on the loan (if any) and the interest that would have been incurred had the official rate of interest been charged on the loan, will be treated as a donation.
This donation is deemed to be made to the trust by that natural person on the last day of his/her year of assessment. Pursuant to section 60, the donations tax must be paid by 31 March every year.
This is an annual event and the natural person is able to utilise his/her annual donations tax exemption against this amount (currently R100,000 per annum). The interest forgone by the qualifying lender of the loan will be treated as an ongoing and annual donation made to the trust on the last day of the trust’s year of assessment.
It is important to note that the legislation is applicable to loans that are in existence on 1 March 2017 and not only new loans entered into after this date.
When is section 7C applicable?
In order for section 7C to apply, the following requirements need to be met:
- There must be a loan, advance or credit;
- That loan, advance or credit must be provided by a natural person, or at the instance of that
- person by a company which is connected to that person
- That
loan must have been directly or indirectly provided to:
- A trust in relation to which that natural person/company is a connected person;
- A trust in relation to which a connected person that is a connected person to the natural person/company (who provided the loan) is a connected person;
- A company if at least 20% of the equity shares/voting rights is held by a trust as explained above; or
- A company if at least 20% of the equity shares/voting rights is held by a beneficiary of a trust as explained above; and
- No interest (or interest below the official rate of interest) is charged on the loan (currently 7.75% in South
Example of Calculation of Donation tax:
A natural person advance funds to a trust in an amount of R10 000 000 and chooses not to charge interest thereon. The natural person has already utilized his annual donations tax exemption of R100,000.
The total donation tax liability on the donation will be R155 000 (= R10,000,000 x 7.75% x 20%).
The Calculation of Donation tax on the above is as follows:
- R10
000 000 x 7.75 % (current interest rate) = R775 000
- R775 000 x 20 % (Donation tax rate) = R155 000
- R155 000 (Donation tax due on the Interest free loan)
It must be noted that section 7C will apply so long as the loan remains in place between the trust and the natural person.
The donation is accounted for by the natural person by way of completing a IT144 from (declaration by donor / donee – available on the SARS website). The form must be submitted at your nearest SARS branch with proof of the relevant donations tax payment and donations tax calculation. It should be noted that the only method of paying donations tax to SARS is by way of a credit push via eFiling.
Lastly, the donation will be regarded as having been made to the trust by the natural person on the day of the year of assessment and donation tax will be payable by the month, following the month during which the donation takes effect. Thus, the donations tax will be payable by 31 March. SARS does levy interest on late payments.
When is section 7C not applicable?
In terms of section 7C(5), the tax consequences of section 7C will not apply:
- If the trust is a Public Benefit Organisation;
- If the trust is a vested trust as to receipts, accruals and assets
- If 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 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.
Our recommendation is that all beneficiary loans should be analysed to establish whether the beneficiary loans are loans provided by the beneficiary or whether it arose from amounts vested in/distributed to the beneficiary.
Where the beneficiary loans arose from amounts vested in/distributed to the beneficiary it is further our recommendation that the trust deed should be reviewed to establish whether the trustees have the discretion to postpone payment of the amounts vested in/distributed to beneficiaries and to propose the relevant amendment if necessary (provided the trust deed permits that the deed may be amended).
Where you have made loans to a South African trust, it is recommended that your position and the impact of this legislation is evaluated. If you have a loan (or loans) which meet the above requirements and would like to have your current position reviewed with regards to the new legislation, we encourage you to seek advice from our tax consulting department.
Our tax team have generated a number of methods to mitigate the effect of this legislation.
Please forward any queries you may have in this regard to Mazars Port Elizabeth at taxpe@mazars.co.za.