It is no secret that, for a long time, the legislator has wanted to close the perceived loophole that taxpayers use to avoid estate duty and donations tax by transferring assets to a trust through an interest-free loan.
The perceived loophole entails that the taxpayer sells his/her assets to a trust, and grants the trust, often with an interest-free loan or a loan with interest below market rates, which is applied by the trust as payment for the assets. In practice such interest free loans do not result in donations tax and the assets so acquired are not included for estate duty purposes.
On 8 July, the draft Taxation Laws Amendment Bill was released for public comment. The draft Bill contains proposed amendments to the Income Tax Act that are intended to address this perceived loophole. It is a bit odd that SARS perceives there to be a perceived loophole that requires intervention, as the Income Tax Act already gives SARS discretion to levy donations tax where it believes a person has made a gratuitous disposition. Apparently the Legislator's intention is to limit a taxpayer's ability to transfer wealth without being subject to tax by proposing the following amendments:
Where a seller (a natural person/company connected to a natural person to the Trust) sells assets to a Trust and the sale of those assets is financed by way of an interest free loan or a loan with interest below market rates, the following tax implications will be applicable:
- The difference between the amount incurred by the trust in respect of a year of assessment and the amount that would have been incurred at the official rate of interest will be included in the seller's taxable income;
- The seller may recover the interest amount that forms part of his taxable income from the trust within a period of three years after the end of the year of assessment in which the income was included in his income. Where the seller does not recover the said amount from the trust at the end of the three year period, that amount will be treated as a donation by the seller to the trust and donations tax will be payable on that amount.
- Section 56(2) of the Income Tax Act will not be applicable in these circumstances and, as such, the seller cannot use that relief to reduce the capital loan amount without attracting any tax on that transaction.
The best route for taxpayers to avoid these consequences will be for any asset sold to the trust on loan account to carry a market related interest. The taxpayer would therefore avoid the unnecessary tax implication like the additional donations tax after the three year period, estate duty consequences as well the income/capital attribution rules. It has in any event always been our advise for loans to a trust to be interest bearing so as to avoid much of the adverse tax consequences that have been in place for some time now.
These provisions will come into operation on 1 March 2017 and, in terms of years of assessment, apply on or after that date.