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Impact of the repo rate on your donations tax liability

A decrease in the rate will reduce the donations tax liability under Section 7C.

The recent reduction in the repo rate from 7% to 6.75% as announced by the Reserve Bank may affect the tax liability of South Africans with an existing loan to a trust. This is because your donations tax liability has decreased as a result of the decrease in the repo rate.

If you have a rand denominated loan, you may need:

  • To do a pro-rata calculation if the loan to the trust is subject to section 7C of the Income Tax Act;
  • To review any interest rate on loans if these were fixed rather than linked to the official rate before July 21 2017.

Section 7C was introduced into the SA Income Tax Act from March 1 this year. This is an anti-avoidance measure aimed at curbing the tax-free transfer of wealth through the use of low interest or interest-free loans, advances or credit. Under Section 7C, an annual and ongoing donation is triggered whenever interest-free loans, advances or credit with low rates (or interest free) are made to the trust by either a natural person or a company that is a “connected person” in relation to the natural person who advances the loan, advance or credit to a trust. 

The tax is calculated at a rate of 20% on the difference between the actual interest charged on the loan, advance or credit and the interest that would have been paid by the trust had interest been charged at the “official rate” of interest as defined in the Act. For a debt denominated in rand, the official rate is equal to the SA repo rate plus 100 basis points (bps). For debt denominated in a foreign currency, it is a rate equal to the equivalent repo rate for that currency plus 100 bps.

The recent change in the repo rate from 7% to 6.75% means that the official rate has decreased from 8% to 7.75%, from July 21 2017

The change in the official rate means that for loans denominated in rand:

  • From July 21 2017, the loan will potentially be subject to Section 7C if the rate is below 7.75% (previously 8% from March 1 2017 to July 20 2017). Where loans have been structured to be 8% (rather than a variable rate based on repo plus 1) these should be reviewed.
  • If you are using your R100 000 annual donations tax exemption under Section 56(1) to apply towards the tax due under Section 7C, the exempt amount increases from R1 250 000 to R1 290 322.58 from July 21 2017. This will need to be calculated pro rate for the different periods (i.e. at 8% from March 1 to July 20 2017 and at 7.75% from July 21 onwards).

This will not, under normal circumstances, have an impact on loans denominated in a foreign currency.

Example

The below example assumes an interest free loan of R20 million from a connected party to a trust where the lender applies the Section 56(1) exemption towards the donations tax liability.

Prior to July 21 2017 (that is, from March 1 2017 until July 20 2017), the first R1 250 000 of the loan was within the Section 56(1) exemption amount (R1 250 000 x 8% = R100 000). With the balance of the loan being R18 750 000, it would mean that an amount of R1 500 000 (R18 750 000 x 8% – the difference between the official rate and the interest free loan is 8%) would be subject to annual donations tax of R300 000 (R1 500 000 x 20%).

From July 21 2017, the first R1 290 322.58 of the loan will be within the Section 56(1) exemption amount (R1 290 322.58 x 7.75% = R100 000). With the balance of the loan being R18 709 677.42, it would mean that an amount of R1 450 000-00 (R18 709 677.42 x 7.75% – the difference between the official rate and the interest free loan is 8%) would be subject to annual donations tax of R290 000 (R1 450 000 x 20%).

Essentially, a decrease in the repo rate will reduce the donations tax liability under Section 7C and an increase in the repo rate will increase the liability under Section 7C. Calculations will be pro rata based on the prevailing official rate during the period in question. However, note that this will need to be calculated pro rate at 8% from March 1 2017 to (and including) July 20 2017 and at 7.75% from July 21 onwards.

Graham Patrick is senior client service manager at Maitland.

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