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Concern about practical challenges with new trust legislation

First donations tax payments due by end of March.

Fiduciary practitioners and tax advisors are very concerned about a number of practical headaches related to tax legislation aimed at curbing the avoidance of estate duty by moving assets to a trust.

My name is Ingé Lamprecht, and to discuss the background and implications of these changes, I’m joined by the chairperson of the Fiduciary Institute of Southern Africa (Fisa), Ronel Williams, and the Institute’s CEO, Louis van Vuren.

Louis, this can get quite technical, but let’s try and keep it fairly simple. The controversial Section 7C of the Income Tax Act took effect on March 1 last year. What does Section 7C entail?

LOUIS VAN VUREN: Ingé, in the past a very popular estate planning practice was to sell growth assets to a trust and to then extend an interest-free loan to the trust for that sale price. That would mean that the estate of the seller would be pegged at that value because the loan would not increase in value as time goes by while the assets would grow in the trust.

Since March 1 2017, Section 7C now deems the interest that is not levied on an interest-free loan, a deemed donation on the last day of each tax year for a loan that was outstanding for any period during that preceding tax year. The interest forgone is calculated by using the official interest rate in the 7th Schedule to the Income Tax Act. The purpose of that official interest rate used to be to determine the fringe benefit that an employee received when the employer extended a soft loan to that employee. Now that official interest rate at the moment is 7.75% and that means that if you have an interest-free loan extended to a trust, that 7.75% of the loan amount would be the deemed donation on the last day of the tax year and then obviously donations tax would be levied on that donation.

INGÉ LAMPRECHT: Ronel, this sounds quite complicated. Why did government believe it was necessary to introduce this change?

RONEL WILLIAMS: Ingé, as Louis said, when the assets are moved to a trust obviously the founder of that trust or the person who moves the assets, removes those assets from his estate. There is a loan in the place thereof, but the asset usually would be something that would escalate in value, which means the growth in the assets take place in the trust. Louis mentioned the loan account is pegged in the estate of the person. When he dies that loan account is subject to estate duty but in all likelihood, it is at a lesser value than what the asset value is.

The other side of it also is that by using a loan to get the assets into the trust, and not a donation, Sars also doesn’t get donations tax at the time when the transaction happens. Treasury’s view is that they are actually losing out on tax by allowing individuals to extend a loan to a trust and not charge interest.

INGÉ LAMPRECHT: Louis, the tax on this deemed donation will have to be paid by the end of March. Now, this sounds easy enough, but it seems that it can be more difficult than it sounds. What are the concerns?

LOUIS VAN VUREN: Well, Ingé the first concern is that loan balances of such interest-free loans do not necessarily stay the same during the full tax year. The donation can only therefore be calculated on February 28 and in fact in a lot of cases cannot even be calculated on February 28 because that would be the date on which trustees would make decisions and sometimes even after that date they would make decisions regarding distributions to beneficiaries of the trust which may influence the loan balance. The first problem is the loan balance is not necessarily determinable on February 28.

In the last tax year, we had a change in the official interest from 8% to 7.75% and that happened on the August 1 2017, which means that you now have to do different calculations for the portion of the year in which the official rate was 8% and the portion of the year in which it was 7.75% and if you add that to the previous point that the loan balances may vary during the year, it could become quite a complex calculation.

The third problem is that not everything that seems to be a loan is necessarily a loan. Now one of the practices in trusts is for distributions to beneficiaries to be borrowed back by the trustees. They would make a distribution to a beneficiary and because the trust needs capital they borrow that distribution back. Now that is a loan, and could influence the loan balance (adding to the previous two points). However, if the trustees distribute a benefit to a trust beneficiary but under the discretion given to the trustees in the trust deed they decide to withhold payment of that distribution, then it is a unilateral decision by the trustees and can never be a loan because a loan is a bilateral legal act. Both parties have to agree to it – the lender and the borrower. In those instances, something like that could never be a loan and it can become quite complex to determine whether you are dealing with a loan or not.

INGÉ LAMPRECHT: Do you agree, Ronel?

RONEL WILLIAMS: Yes, Ingé. Louis has pointed out quite a few problems. What we need to take into consideration is that the financial statements of the trust is the accurate description or indication of what the loan amount would be. As the tax year only ends on the 28th or the last day of February of every year, the financials cannot be drafted until quite some time after that because there are tax certificates that are required. A lot of financial institutions only start providing the tax certificates around May of the following tax year. So those financials cannot be completed. The tax returns cannot be completed. Until the trustees have all that information they are often not in a position to accurately determine what those loan accounts are.

One of the things for example is that if a trust has an offshore investment through what we traditionally refer to as an asset swap investment, one of the requirements in order to calculate what the foreign gain is, is to know what the average exchange rate was for the particular year. Sars only publishes those into the new year, usually about two or three weeks into March. It is impossible at the end of February to actually do the calculation and all of this just adds up, that the trustees cannot make their accurate decisions of exactly what it is that they are going to be distributing to beneficiaries and then to see how that impacts the loan account. 

INGÉ LAMPRECHT: What about the donations tax payment, Louis? Is that a straightforward process?

LOUIS VAN VUREN: Unfortunately not, and it seems that Sars will have to do some systems development here and that systems development will not be ready by the end of March 2018 when the donations tax payments are due under Section 7C.

Firstly, the additional payment of this donations tax needs to be loaded onto eFiling and processed via what is called a “credit push” authorisation. That in itself creates a problem because that amount that is paid will then stand to the credit of that particular taxpayer and will in the normal run of events be regarded as an overpayment of income tax. To prevent that, an IT144 form needs to be manually completed and submitted to Sars along with proof of payment. Only then can Sars allocate the donations tax payment to donations tax and not see it as a credit on income tax payable for that taxpayer.

We are also very concerned that there seems to be insufficient capacity within the Sars offices to process these IT144 forms within this short timeframe of 31 days to get the payment done.

INGÉ LAMPRECHT: Ronel, section 7C was amended last year to extend the provisions regarding low interest or interest-free loans provided, to a company under certain conditions. What are the implications of this amendment?

RONEL WILLIAMS: When Section 7C was initially introduced, a lot of taxpayers saw the opportunity to restructure their plans, so what did apparently happen in practice – and definitely what Treasury thinks is going to happen – is that the loans that were owing by the trust were then repaid to the individual and then on-lent to a company usually where the trust would hold the shares in the company. Now Treasury saw this and they realised that Section 7C actually didn’t cater for that so they’ve extended the application and they’ve now made it applicable where there is a loan to a company where at least 20% of the shares or the voting rights are held by the individual or by a trust to which that individual is a connected person. Then Section 7C will apply to that, but they’ve also extended it – they’ve gone even further and they’ve said that it will apply to any loan made by a company to a trust if the natural person who is the shareholder of the company is also a connected person to the trust. There is no specific need that there must actually be a connection between the trust and the company as long as there is an individual that is somehow connected to both.

INGÉ LAMPRECHT: Louis, could you perhaps explain this by way of a practical example?

LOUIS VAN VUREN: Yes, Ingé. Incidentally I recently consulted with a client – let’s call him Fred. Fred owns 100% of the shares in a private company – a bona fide trading company incidentally holding franchises for fast food outlets. At the same time Fred is also one of three trustees of a trust which owns the farm on which he lives and farms. So as a result of this, any loan by either Fred or the company to the trust falls within Section 7C and what has happened during the last tax year is Fred’s company had some spare cash and without thinking too much about the consequences and being unaware of the consequences, an amount of that was paid into the bond that the trust gave over the farm to a bank to reduce the outstanding balance and thereby save interest for the trust. That in itself then means that that payment represents an interest-free loan by the company to the trust. The company and the trust are not connected in any way. The trust does not hold any shares in the company, but because Fred is a connected person with regard to the trust and because he holds 100% of the shares in the trading company, this falls under Section 7C with the obvious result that there is this deemed donation [on the last day of February] except if he now gets the company to levy interest on that loan. The purpose of this payment into that bond was never to avoid estate duty – it was finding a practical way of making his money work for him without thinking about the fact that he was dealing with two separate entities that he is on both sides connected to.

INGÉ LAMPRECHT: So where to from here, Ronel? What would be your advice to people who are affected by these changes?

RONEL WILLIAMS: I think it is very important that anybody who is affected must get professional advice. We did say initially when Section 7C was implemented that was exactly the advice given is that although in theory it sounds pretty straightforward, and you can break it down, there is no one-size-fits-all solution for every client. Every client’s situation is going to be different and they need to look at it in the context of their circumstances – the bigger planning etc.

Similarly, now with the extension of Section 7C to also look at loans to companies, I think that becomes quite technical and that just makes it even more important to get professional advice. Speak to a tax advisor or a fiduciary advisor who can assist you to do the best type of planning and see what will work.
INGÉ LAMPRECHT: Thanks for the insight. That was the chairperson of the Fiduciary Institute of Southern Africa, Ronel Williams and its CEO, Louis van Vuren.

  • The Fiduciary Institute of Southern Africa (Fisa) sponsored this content.



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Thank you for insights. If one adds the VAT increase trust companies have a lot of communicating to do. In my experience many lenders do not keep track of their donations ‘writing off loan accounts & have ignored warnings on 7C interest

So the trustees say they give the money to the beneficiaries who then loan it back to them? But the money is never actually paid across and back again and it is just accounting smoke and mirrors? Surely if the money stays in the trust then tax it in the trust? If it vests then tax the beneficiary and it becomes part of his estate? If he wants to loan it back to the trust then draft a loan agreement before the transaction is done and not after the fact with accounting backfill.

Yes, you’re right that any income or capital gain that is vested in a beneficiary is taxed in that beneficiary’s hands. This will be taxed, at worst, at the same marginal rate (45%) at which the trust would have been taxed. If the beneficiary then takes part in a transaction in which distributed income is borrowed back interest free by the trustees, the foregone interest (the difference between 0% and 7.75%) will be a deemed donation by the beneficiary to the trust. However, if the trustees take the decision to vest income in the beneficiary but withhold payment of such a distribution without the co-operation of the beneficiary, the income will still be taxed in the hands of the beneficiary (and the trust will usually pay the tax out of the withheld income. In this case the withheld income can never be a loan as the beneficiary took no part in the transaction. The income distributed but withheld remains vested in the beneficiary and should be shown in the trust accounts as a distribution due to the beneficiary. It now belongs to the beneficiary, but is kept under control of the trustees. Obviously this can only be done if the trust deed gives these powers to the trustees.

Thank you, Louis, that clarifies it very well. It does seem that round-tripping the loan is not in the spirit of the law and is anti-avoidance. It is difficult to find sympathy for people then complaining about the mechanics of donations tax. Is it not just a matter of filling in the IT144 form and doing an EFT?

The fact that people are using loans are not necessarily an indication that they are unfairly avoiding tax (whatever that may mean). Neither is it justification to burden taxpayers with an administrative nightmare and a situation where the taxpayer is surrendered to the discretion of a local SARS manager whether a penalty is going to be levied on late payment. The law and process should always be such that it is possible for the taxpayer to comply. In this case it will not be in a large number of cases.

Also, just bear in mind that there are very good reasons (that have nothing to do with tax) to make a distribution from a trust without actually paying it out. In a trust with a number of income beneficiaries of varying ages (in some cases a testamentary trust where there was no possibility to avoid estate duty) the trustee(s) may decide to distribute because some of the beneficiaries need the cash. In order to ensure fair treatment and avoid complex calculations later, the trustee(s) may then decide to distribute an equal amount to all the income beneficiaries. One of these may be a final year student and the trustee(s) may (for very good reasons) decide to withhold payment of the distribution until the beneficiary has passed his/her final exams. That is why the distinction between what is actually a loan and what not is so important.

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