Interest free loans to trusts and companies have always been a very efficient mechanism for estate planning and restructuring purposes but section 7C of the Income Tax Act 58 of 1962 (“Act”) has changed the scene and can this mechanism impose unfavourable tax consequences.
Section 7C of the Act specifically addresses loans or credit advanced to a trust or a company on which no interest or below market related interest rates are charged by the lender. The legislation provides that where a natural person makes an interest-free or below market related interest rate loan or advance to a trust or company, the non-charging or interest or below market related interest rate charged will be regarded as a donation subject to donations tax at the rate of 20%.
This section applies to any loan, credit or advance granted directly or indirectly to a trust or company by any connected natural person or company in relation to whom the natural person or trust is a connected party too.
Let’s consider a practical example, where an individual who is a connected person to an inter vivos trust, advances an interest free loan to a trust or a company of which the trust is a connected person to the individual advancing the loan, the provisions of section 7C will apply. The result will be that 7.75%, which is the current official interest rate, of the loan amount will be deemed a donation and taxed at the 20% donations tax rate for each year during which the loan is in existence. If an interest rate lower than the official interest rate is charged, for example, 3% the difference between the official interest rate of 7.75% and 3%, thus 4.75% of the loan amount will be deemed a donation and taxed at the 20% donations tax rate for each year during which the loan is in existence.
It is important to take note that section 7C applies in respect of all loans made on, after, or before 1 March 2017 and therefore applies in respect of pre-existing loans on which no interest or a below market related interest rate is charged and will surely impact future estate planning.
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