The application of the anti-avoidance rules for low-interest or interest-free loans from South African residents to foreign trusts seems quite simple, but it comes with tricky calculations and requires a level head.
The proposed change in the draft Taxation Laws Amendment Bill (TLAB) aims to address an anomaly in the legislation and clarify the policy intent of the trust anti-avoidance measures.
The measures currently specifically exclude any low-interest or interest-free loans that constitute “affected transactions” (transactions between connected persons who do not transact at arm’s length) that are subject to the transfer pricing rules.
This exclusion was historically provided to avoid double taxation in terms of the anti-avoidance rules, which levy donations tax, and the transfer pricing rules, which also levy donations tax.
Webber Wentzel tax partner Joon Chong says National Treasury proposes to shut down any “improper or undue structuring opportunities” when residents provide low-interest or interest-free loans to foreign trusts.
The exemption
Currently, the section 7C anti-avoidance rules on these loans to non-resident trusts do not apply if the transfer pricing rules in section 31 apply to the loans.
Section 7C of the Income Tax Act is an anti-avoidance provision aimed at preventing the tax-free transfer of wealth to trusts using low-interest or interest-free loans, advances, or credit arrangements, including cross-border loan arrangements.
Cliffe Dekker Hofmeyr explained that the mechanism for anti-avoidance comes in when the interest rate charged on loans made by individuals to trusts and certain connected-person companies is lower than the official rate of interest.
The difference between the interest charged and what would have been charged at the official rate of interest will be treated as a deemed donation.
One of the exclusions is where the transfer pricing provisions in section 31 apply to a cross-border loan made by a South African resident to a non-resident. Section 31 states that one must consider whether the terms of an affected transaction, including a loan, adhere to the arm’s length principle.
“Treasury proposes to narrow the transfer pricing exemption to apply to these loans only to the extent of an adjustment made in terms of section 31(2),” says Chong.
Policy intent
Phia van der Spuy, the founder of Trusteeze, says the policy intent remains the same, but the previous wording regarding the exclusion of the anti-avoidance measures created an unintended tax advantage in situations where the arm’s length interest rate is lower than the official rate. That was not the intent of the exclusion, because it was introduced only to avoid double taxation, not to provide a tax advantage.
National Treasury explains by way of the following example:
X, a resident natural person, makes a non-arm’s length interest-free cross-border loan of R10 million to a connected non-resident trust, and a tax benefit is derived. If the trust had borrowed the funds from a bank, it would have paid interest at a market-related rate of 5% a year (R10m x 5% = R500 000).
The official rate of interest for tax purposes is 8%. Since this is not an arm’s length transaction, the cross-border loan is subject to the transfer pricing rules of section 31. This results in X having a primary adjustment to its taxable income of R500 000 in terms of section 31(2) and a secondary adjustment in terms of section 31(3) of the Act, a deemed donation of R500 000.
As it was a non-arm’s length transaction, the anti-avoidance exclusion of section 7C(5)(e) of the Act is applied. If the transfer pricing rules did not apply, the taxpayer would have had to declare a deemed donation of R800 000 (R10m x 8%).
The R300 000 is an unintended anomaly in the interaction between the trust anti-avoidance measures and the transfer pricing rules. “This can create structuring opportunities that if left without legislative intervention, could lead to the erosion of the tax base,” Treasury concludes.
The rates
The proposed amendment aims to ensure that the exemption to the trust anti-avoidance measure only applies to the amount “to the extent of an adjustment being made on that amount or part thereof” in terms of the transfer pricing provisions.
Van der Spuy says it is a simple wording change from “subject to” the transfer pricing provisions to “the extent of an adjust made”, which means a calculation must be performed to establish to what extent section 7C applies.
It is this difference between the official and the market-related rates that creates room for structuring. If the market-related rate of the loan is more than the official rate, there is no threat of leakage to the fiscus.
However, when the market-related rate is lower than the official rate (as in Treasury’s example), there may be a leakage to the fiscus. This is what Treasury wants to prevent.
“If the rates were aligned, there would not have been this anomaly. The difference in rates in the two sections meant that Treasury had to build in a catch-all to prevent leakage,” says Van der Spuy.
Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law, and regulatory issues.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article does not constitute financial planning, legal or tax advice that is appropriate to every individual’s needs and circumstances.
