Trusts were usually considered the go-to entity when people wanted a relatively easy way to ensure that their property is safeguarded from creditors and that their taxes are managed in a way that was seen as ‘cost-effective’, especially from an estate duty perspective.
It is no secret that the South African Revenue Service is anti-trust. Uncertainty about the effectiveness of trusts arose due to speculation over the past few years and finally a new draft bill proposing the feared and much-debated section 7C of the Income Tax Act. The rumours about this section have caused numerous property owners and part-time farmers to sell their property in order to avoid the much talked-about tax consequences should this section be implemented.
The good news is that after many heated debates, the impact of the newly proposed section 7C is still material but definitely manageable. The new section proposes that all loan accounts to a trust that are either interest free or at a lower than determined interest rate will be seen as ‘donations’ made on a monthly basis – in other words, the ‘interest’ that you as the trustee/beneficiary are supposed to receive from the trust, will now be considered a donation which is liable for donations tax at twenty percent. This effect is less severe than originally anticipated, being that the whole loan would be seen as a donation liable for donations tax.
Taxpayers also have to remember that each natural person in South Africa can donate up to R100 000 per year which will not be subject to donations tax. This implies that if the donations tax of twenty percent on the ‘interest’, which is seen as the donation, is less than R100 000 per year, there will be no tax implication. If the R100 000 is utilised against another donation, the whole interest amount will be subject to donations tax.
This section will not be backdated, but it will be applicable to all existing loans in trusts. There is a bit of uncertainty as to whether this section is applicable to ‘pure’ loan accounts only or all loan accounts that include for example distributed capital and other income that have not yet been paid out to the beneficiaries.
This also puts a damper on the popular method of ‘freezing’ your property value for estate duty purposes. Most estate advisors usually recommended that taxpayers freeze the value of their property to be included in the estate by transferring the property to a trust. In this way, the only asset in the taxpayer’s name is the original loan amount which is the value of the property on the date that it was transferred. This method prevents that the appreciation in value of property is included in the taxpayer’s estate. Although it is still possible to do this, the new section will have to be scrutinised to determine whether this is still an effective way of tax and estate planning.
Marese Lombard (CA(SA)) is a lecturer at the School of Accountancy, University of the Free State