Tax practitioners are gravely concerned about a host of practical issues related to the implementation of new tax regulation aimed at curbing the avoidance of estate duty by moving assets to a trust.
The controversial Section 7C of the Income Tax Act, which took effect on March 1 2017, means that any loan made to a trust by someone who is a connected person to the trust (usually the founder, trustees or beneficiaries) and that does not attract interest at least equal to the official rate of interest (currently 7.75%) is deemed a donation on the last day of each tax year the loan remains outstanding. The donation is equal to the difference in the interest payable on the loan and the official rate.
Previously taxpayers often moved assets to a trust while extending an interest-free or low-interest loan to the trust to finance the transaction. The practice effectively allowed people to divest themselves from a wealth generating asset by transferring it to a trust, thereby pegging their estate duty liability to the outstanding loan, ignoring the asset’s increased value upon death.
As a result of the new regulation, donations tax on these types of transactions will have to be paid before the end of March 2018. Donations tax is payable on the last day of the month immediately following the month in which the donation was made.
But there is significant worry that taxpayers won’t be in a position to correctly calculate the values of the loans made so shortly after the financial year end, while simultaneously ensuring that the donations tax is paid on time and accurately reflected on the South African Revenue Service’s (Sars) system.
While the requirements seem simple on paper, in practice a trust’s financial statements and tax return are often only finalised several months after the tax year-end, Louis van Vuren, CEO of the Fiduciary Institute of Southern Africa (Fisa), explains. Loans may still be affected by trustee decisions, while the loan balances of some trusts can fluctuate from month to month. At the same time, a change in the official interest rate – as was the case during 2017 – will also impact calculations. Practically, these issues create a significant challenge to calculate the deemed donation accurately within one month of the end of the tax year.
This is placing a significant administrative burden on the industry, adds Barry Pogrund, partner at MGI Bass Gordon.
There are often a number of taxpayers who extend loans to the trust and it can be difficult to get hold of them and monitor whether the donations tax was paid. There is also uncertainty regarding withheld distributions and how it is impacted by Section 7C. The concern is that Sars may in future attack a planning framework where distributions are withheld in line with the requirements of the trust deed, Pogrund says.
Although donations tax payments can be made via the eFiling website, it can only be done using the “credit push” option. At this point donations tax payments via electronic funds transfer (EFT) do not have a specific tax number associated with it. Tax legislation requires that the payment be made within one month and that the return be submitted within three months, creating a mismatch between systems, an industry insider says.
The taxpayer must also attach proof of payment to the return filed. This is the only tax in SA payable before the tax filing deadline, and Treasury’s attention was drawn hereto. Donations tax is also the only local tax paid without the use of a unique tax identifying number, leaving the system open for abuse and confusion. Using one’s income tax number has resulted in Sars refunding the donations tax as it was incorrectly captured as an advance tax payment, he adds.
Industry specialists suggested it would have been easier if Sars created a special 7C process on eFiling, allowing the system to link the deemed donor with the deemed donee. Both need to sign the IT144 return, yet there is no method to link the return to one or multiple trusts.
“We really have a deadline problem and Sars’ system is not making it any easier.”
The matter was further complicated with the extension of 7C to loans made to companies connected to trusts. The effective date is July 19 2017 not March 1 2017 as for trusts and because of the change in repo rate, loans to companies are subject to interest at 8% for 12 days and 7.75% thereafter.
Industry has made peace with the new legislation and wants to ensure that clients comply, but will find it difficult if procedures are not in place to facilitate a smooth process, the insider adds.
One proposal put forward, is that taxpayers should be allowed to make an initial payment six months after the tax year end, and be allowed to apply for an extension to submit a final return without paying penalties. A similar practice is being followed with regard to estate duty.
As a result of time and resource constraints, Fisa requested that the due date for submission of the IT144 return and payment of donations tax should be extended annually to August 31, Cheryl Howard, managing director of Talaria and a Fisa member, says.
It is concerned that Sars has not settled the methodology for computing the interest, that the process for completing the IT144 has not been finalised and about the manual payment of the donations tax and the limitations imposed by Sars on the number of cases that can be attended to at a branch, she says.
Where taxpayers or funders of companies and trusts wish to charge interest and so legally void the imposition of s7C deemed donations, the interest charge must be taken into account for their personal income tax and end February 2018 provisional tax. The payer of the interest is duly allowed to reduce their taxable income and will not be using past assessment as the base of calculations.
These changes have added to the workload around February and March, just before Easter as accountants will not have access to interim or management accounts, the insider notes.
Sars did not respond to requests for comment by time of publication.