The impact of section 7C of the Income Tax Act on taxpayers will become evident soon
The end of the tax year is fast approaching, signalling the first date on which some taxpayers will experience the impact of section 7C of the Income Tax Act. The purpose of this section is to prevent taxpayers from using trusts to avoid or reduce estate duty and/or donations tax.
Over the last couple of months, section 7C has received extensive media coverage and we have sent out several communications explaining the potential impact. This article serves as a brief reminder of the scope of section 7C, the latest changes, and what it may mean for you.
Section 7C in a nutshell – a loan to a trust can be deemed a donation, subject to donations tax
Section 7C states that, where a person who is a connected person in relation to a trust makes a loan, advance or credit (directly or indirectly) to the trust and charges either:
The person is deemed to have made a donation, equal to the difference between the actual interest rate charged and the official rate. (When section 7C was first introduced, the official rate of interest was 8.00%, but since 1 August this year it has been reduced to 7.75%.) The same provision applies where a loan is made by a company to a trust, on request of the connected person.
Loans made before or since 1 March 2017 are affected
For the past tax year, such donations will be deemed to take place on the last day of the tax year (ie 28 February 2018), and the donations tax will be payable at the end of the following month (ie by 31 March 2018). It’s important to consider that, although section 7C was only introduced with effect from 1 March 2017, it applies to loans already in existence at that date, as well as loans made on or after that date.
The following example illustrates the potential tax implications
|Scenario||Tax calculations and implications|
Value of the donation:
R2 million x 8% (assumed interest rate) = R160 000
Taxable amount for Scenario A:
R160 000 – R100 000 exemption = R60 000
Donations tax payable:
R60 000 x 20% (the tax rate on donations) = R12 000
Taxable amount for Scenario B:
R160 000 (no tax exemptions)
Donations tax payable:
R160 000 x 20% = R32 000
Exemptions where section 7C won’t apply
The most important exemptions include the following scenarios:
Vested amounts will not be regarded as a loan, subject to certain requirements
A trust’s income or capital is often vested in (distributed to) a beneficiary, which means the distribution is taxed in the hands of the beneficiary, but not physically paid to that beneficiary. The purpose of this is to enable the beneficiary to still invest the distribution in the trust, thereby obtaining better growth.
Although this is not technically a loan extended by the beneficiary to the trust, it has been an accounting practice to reflect such vested amounts in the trust’s annual financial statements as a loan account. National Treasury has however clarified that such vested but unpaid amounts will not be regarded as a loan account for the purposes of section 7C, subject to the following requirements:
|The vested amount may not be paid to the beneficiary until a certain event takes place or until the beneficiary reaches a certain age, as provided for in the trust deed.||OR||
Proposed changes to section 7C widens its application significantly
National Treasury responded to what they refer to as ‘schemes’ devised to circumvent section 7C with the revised draft of the 2017 Taxation Laws Amendment Bill (TLAB), introduced on 25 October 2017. The revised Bill extends the application of the section to interest-free or low-interest loans made to a company in which the trust or a beneficiary of the trust holds at least 20% of the equity shares or voting rights. This proposed change makes the application of the section very wide, since it means that the trust does not have to hold any shares in the company to which the loan is made. The only requirement is that the lender is a connected person to the trust of which a beneficiary holds shares in the company.
It is important to note that, although the TLAB has not yet been promulgated, this change is effective from 19 July 2017, applying to any amount owed by the trust or company before, on or after that date.
Section 7C’s impact will vary, so it’s best to get expert advice about your situation
It is evident that section 7C will continue to have a big impact on taxpayers. If you have a loan owing to you by a trust or company and you have any questions or concerns, we urge you to speak to your relationship manager. They can put you in touch with one of our fiduciary specialists who can determine the best way to deal with the loan. There is no ‘one-size fits all’ solution that will eliminate the consequences of section 7C and your specific circumstances will have to be assessed on its own merits.
|Please contact your relationship manager if you would like specialist fiduciary advice about what this update may mean for your wealth.|
|Estate planning: A letter of wishes is a useful guide for trustee|
|Wills: The importance of having a valid, updated will|
|International: Potential tax law changes that may affect you|
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