Effective from 1 March 2017 section 7C will apply to all loans, including loans currently in existence, made to a trust by connected parties (including the founder, trust beneficiaries and any relatives of such beneficiaries as well as connected companies) where no interest or interest below the official rate of interest is charged (currently 8%).
The consequences:
The difference between the interest rate charged and the official interest rate of 8% in the hands of the lender will be treated as an ongoing and annual donation on the last day of the tax year and will be subject to donations tax at a rate of 20%.
Transactions not affected:
Here are some transactions that will not be affected by 7C:
- Vesting trusts like most testamentary trusts;
- Special trusts;
- A loan made to a trust to purchase a property which property is used as a primary residence by the person or his/her spouse throughout the year of assessment.
Example:
Mr X made an interest-free loan to a trust of R5 000 000. The trust bought a primary residence for R3 500 000. The remaining R1 500 000 was used to buy an endowment policy.
The result of the above transactions is that 7C will only be applied in respect of the R1 500 000 not used for purposes of acquiring a primary residence.
Section 7C calculation works as follows:
Donation: (R5 000 000 – R3 500 000) x (8% – 0%) = R120 000
Donation tax payable R120 000
Less annual exemption R100 000
R20 000 taxable at 20% Donations tax payable of R4 000
Donations to the value of R1 250 000:
Interest-free loans up to R1 250 000 will not give rise to donations tax –
Donation: R1 250 000 x 8% = R100 000
Donation tax payable R100 000
Less annual exemption R100 000
No donations tax payable.
Interest charging loans to a trust:
Section 7C does not apply to loans made to a trust where interest is charged at the official rate (currently 8%). Such interest will be taxable interest in the hands of the lender while the trust will only be able to deduct the interest from taxable income if it was incurred in the exercise of a trade. This may result in paying income tax at a higher rate than the donations tax. To capitalise the interest, the loan account and further interest thereon will be counterproductive as it will reduce the estate duty saving further.
Conclusion:
Clients should not panic and make rash decisions to close down their trusts and dispose or distribute trust assets before getting appropriate advice. The problem might not be as serious as it seems.
With proper planning, there will be ways to limit the effect of section 7C.
For assistance or any advice on trusts, contact our office at 010 007 2376 or ()