How does this new attack from SARS on trusts work?

Traditionally, people moved their assets into a trust to stop/freeze the growth in their personal estates for Estate Duty purposes. It was often the case that trusts did not have the liquidity to pay for these assets. The alternative was to sell the assets on loan account to the trust. This loan was generally never repaid. No interest was charged either, as an interest charge would inflate the estate of such person (which the trust structure was supposed to freeze) and income tax would be payable on the interest by such person. As an example, if a person transferred his house into a trust for R 100 000, on loan account, and that person died thirty years later, the only asset in his name would be the original R 100 000 loan, even though the asset may have increased in value to, say, R 10 million. The Estate Duty saving on the increased value is clear.

The South African Revenue Service (SARS) has been unhappy about Estate Duty capping for years. They have considered measures whereby individuals would be taxed on the growth in their estates, based on the growth that is taking place within their trusts instead. The tax that they have come up with to compensate for their loss of Estate Duty falls within the ambit of Donations Tax, which is charged at the same rate as Estate Duty (20%). This will have the effect of the estate planner having to pay “death taxes” during his/her life on this potential growth, calculated at the official rate (currently 7.5%, being the repo rate plus 1%), irrespective of whether assets transferred to the trust grew at that rate. 

Who it applies to:

SARS taxes all interest-free (or interest charged below the official rate) loans made by resident natural persons to trusts directly (if they are connected persons to the trusts), or to companies, where at least 20% shares are held by trusts (alone or with connected persons). One of the most important exclusions is the funding of a primary residence in a trust.

The provision has been extended to include loans bequeathed to connected persons (such as your child or spouse). When the loan is transferred to the legatee/heir, he/she will be deemed to have made the loan on that date.

Depending on how you interpret it, Section 7C may also apply to amounts distributed/vested by a trust in a trust beneficiary, but which are not physically paid to the beneficiary. These may be seen as loans, made up of unpaid distributions. Ensure that the trust deed makes it clear that such unpaid distributions will not constitute loans by beneficiaries to the trust. Trustees ought to give consideration when drafting the trust’s financial statements to clearly separate unpaid distributions as elected by beneficiaries (loans) versus unpaid distributions as selected by trustees (creditors). 

This deeming provision relates only to the lender, not the borrower, and as such the related trust will not be deemed to have incurred an interest expense of a similar amount. Absolutely no accounting or tax entries are to be made in the books of the trust.

From when applicable:

It came into operation on 1 March 2017. All existing loans on that date and new loans made after that date are affected. It is an annual tax payable, and the first payment was due on 31 March 2018. 

How it works:

This provision does not require one to actually charge interest on loan accounts to trusts. The affected natural person can decide to do one of the following:

1. To charge interest on the loan of at least the official rate. Although no additional tax will then be payable under Section 7C, such person will be taxed on the interest charged, if the individual, as a lender, exceeds his/her annual natural person interest exemption    (R 23 800). The interest amounts will also increase his/her estate, on which Estate Duty will be payable upon death. The trust may also not be in a position to deduct the interest expense in its hands for Income Tax purposes, as often trusts are not trading. Charging interest may undo most of the Estate Duty benefits of moving assets into a trust.
2. Alternatively, charge no interest on the loan. In this instance, a calculation will have to be performed on the difference in interest between the official rate, and what is charged. Interest charged at below the official rate will be deemed an ongoing annual donation made to the trust on the last day of February each year.
   Interest should be calculated daily, so you cannot repay the loan the day before the end of February, in order to avoid this tax. Should the official rate change during a month, the new rate should be applied from the first day of the following month. Donations Tax of 20% will be payable as calculated, by the person who granted the loan. Section 7C has, in fact, nothing to do with Income Tax, even though the calculation is done on the interest that should have been charged on the loan.
   The Donations Tax exemption of R 100 000 per annum may be applied against the deemed donation. For example, with the current official rate (7.5%), a loan with a value of R 1 333 333 will not attract any tax for purposes of Section 7C {(R 1 333 333 x 7.5%) –  R 100 000 annual donation}. This annual exemption was always used by estate planners to reduce any loans to the trust, but it can now be used to reduce the annual tax liability on such interest-free loans, instead. Estate planners should however be mindful of the implications of such outstanding loans in the instance of a liquidation and upon death.
3. Charge interest at a rate less than the official rate. Section 7C will then be applicable to the difference between the official rate and the interest rate charged. If no other interest is earned by the person concerned, he/she can use the annual interest exemption of      R 23 800, and have a loan of R 317 333, which will not attract taxation as per Section 7C. If one uses the R 100 000 annual donation exemption, and the annual interest exemption, a loan of R 1 650 666 (with an interest rate of 1.442%) will attract no tax under Section 7C, and no tax will be payable on interest received by the lender. 

Remember, it is not always simply about the tax savings or the additional taxes payable on assets transferred to a trust; it is also about a strategy to protect your assets, to create continuity and liquidity upon your death, as well as other considerations, such as a contingency plan should you develop a mental disease, such as Alzheimer’s Disease. Consult a professional.