SECOND DRAFT OF SECTION 7C
On 25 September 2016 the National Treasury issued the ‘second batch’ of the 2016 Draft Taxation Laws Amendment Bill (TLAB) for public comment (see the Monthly Listing).
This second batch incorporates amendments consequent upon public comments received on the ‘first batch’, published on 8 July 2016.
The draft TLAB proposes the introduction, effective as from 1 March 2017, of a specific anti-avoidance measure, in s 7C of the Income Tax Act, aimed at curbing the tax-free transfer of wealth through the use of low-interest or interest- free loans to trusts.
These are used in classic estate-pegging exercises, in which growth assets are transferred to a trust to accumulate there, thanks to an interest-free loan. Upon death, the lender’s estate is dutiable only on the original loan.
The ‘first batch’ draft TLAB proposed that the difference between the official rate of interest for tax (currently 8%) and actual interest charged on the soft loan be treated as income and subjected to income tax annually, on a deemed-interest basis.
For example, under an interest-free loan to a trust, deemed interest of 8% would accrue to the lender.
The ‘second batch’ draft TLAB proposes a more benevolent tax dispensation, namely, that the deemed interest will no longer be treated as income but as an ongoing, annual donation made by the lender on the last day of the lender’s tax year.
Thus the effective cost to a lender would be 1,6% a year—20% (donation’s tax rate) of 8% (official rate of interest).
Annual donations tax exemption
The current annual donations tax exemption of R100 000 in each tax year (56(2)(b)) will remain.
Thus a loan may continue to be written down by the lender, or alternately, monies donated to a trust, free from donations tax.
It is proposed that the following exclusions will apply:
- Special trusts (disability trusts).
- Trusts classified as public benefit organizations.
- Vesting trusts (as distinct from discretionary trusts), under which beneficiaries are subjected to tax upon receipt or accrual of income to the trust.
- A loan to be used by the trust to acquire a primary residence.
- A loan to a nonresident trust already subject to the deemed-interest repricing provisions of s 31.
- Loans to a trust under a sharia-compliant financing arrangement.
- A loan treated as a dividend under s 64E(4).
The proposal applies to all loans (including those in existence before 1 March 2017).