The effect of no-interest loans to trusts

One way of avoiding estate duty and donations tax is to sell an asset to a family trust for a market related value.

The rationale is to freeze the growth of the assets in the taxpayer’s estate for estate duty purposes. The income tax benefits would accrue to the beneficiaries of the trust after the death of the taxpayer, as the income received by the trust and distributed to them would be taxed in their own hands at their respective tax rates. 

Where the problem arises, for SARS, is that the selling price of the asset is usually payable, interest-free, on loan account. Following the sale of the asset, the purchase price due by the trust is reduced every year by the taxpayer waiving R100 000 of the loan. This waiver would be exempt from donations tax and no CGT implications would arise for the trust, the debt would be reduced by way of a donation.

To close the us gap, section 7C was introduced to the Income Tax Act to address situations where assets are disposed of to a trust on interest-free loan account. The effective date is 1 March 2017, and provides that where there is an interest-free loan or a loan which is repayable at an interest rate below the official rate (currently set at 8%), the difference between the set interest rate (usually 0%) and the official rate (namely 8%) is regarded as a donation which will attract donations tax levied at a rate of 20%. 

One effect of the application of section 7C would be that any interest forgone by the taxpayer in respect of the interest free or low interest loan would be treated as an ongoing and annual donation to the trust. The good news is that natural person (or a company that is a connected person in relation to that natural person), are not precluded from employing the annual donations tax exemption of R 100,000.00 donation to the trust. If an individual donates R 100,000.00 or less, section 7C will not be applicable and no interest will be deemed to have accrued to the individual.

For larger donations, the effect may be to neutralise the historic estate planning structures.