Amendments will be made to the Income Tax Act to clarify the rules designed to prevent taxpayers from using low-interest or interest-free loans to trusts to avoid paying tax.
The proposed amendment is contained in the 2023 draft Taxation Laws Amendment Bill, which is one of the draft bills and regulations that will give effect to the tax proposals announced in the 2023 Budget.
National Treasury and the South African Revenue Service (Sars) published draft legislation for public comment at the end of last month.
The authorities have been steadily clamping down on the use of low-interest or interest-free loans, advances, or credit to trusts to avoid tax.
The tax-avoidance structures involved taxpayers transferring assets to trusts where the purchase price that the trust owes in respect of the assets is left outstanding on a loan account in favour of that taxpayer, but no interest or very low interest is charged. Alternatively, taxpayers would advance a low-interest or interest-free loan, advance, or credit upfront to a trust so the trust could acquire assets.
In 2016, measures aimed at curbing the use of such structures were introduced in section 7C of the Income Tax Act.
Taxpayers devised other structures to circumvent these anti-avoidance measures, National Treasury says. For example, taxpayers advanced interest-free or low-interest loans to companies owned by trusts because initially the anti-avoidance measures focused solely on interest-free or low-interest loans, advances, or credit that were made by a natural person or a company (at the instance of a natural person) to trusts.
Consequently, the rules were strengthened in 2017 so that interest-free or low-interest loans, advances, or credit that are made by a natural person or a company (at the instance of a natural person) to a company that is a connected person in relation to a trust are also subject to the anti-avoidance measures.
In 2020, further changes were made to section 7C to curb the use of schemes that sought to bypass the anti-avoidance measures by way of natural persons subscribing for preference shares with no or a low rate of return in a company owned by a trust that is a connected person to those individuals.
What needs to be clarified?
First, where the provisions of section 7C apply, any interest foregone in respect of low-interest or interest-free loans, advances, or credit owed by any trust or company is deemed to be a donation that is subject to donations tax.
The deemed donation is calculated as the amount by which the official rate of interest exceeds any amount of interest incurred in this regard.
However, where the low-interest or interest-free loan, advance, or credit owing by a trust or company is denominated in foreign currency, the provisions of the anti-avoidance measure do not provide guidance to taxpayers on how and when this amount should be translated into rands.
Second, a deemed donation is not triggered under the provisions of section 7C where certain exclusions apply. For example, there is an exclusion for where the low-interest or interest-free loan, advance, or credit is used by a trust or company to facilitate the acquisition of a primary residence for a person advancing that low-interest or interest-free loan, advance, or credit, or a spouse of such person.
The exclusion in respect of a primary residence does not fully encompass what constitutes a primary residence in terms of the Eighth Schedule of the Act.
The proposed amendments
Determination of deemed donation in respect of debt denominated in foreign currency
It is proposed that changes be made to the legislation to provide guidance on the determination of any deemed donation that is triggered by the application of the anti-avoidance measure in respect of low-interest or interest-free loans, advances, or credit that are denominated in any currency other than the South African rand.
It is proposed that for purposes of determining the amount to be treated as a donation, any foreign-currency-denominated debt outstanding at the end of the year of assessment of the trust or company that owes the tainted loan, advance, or credit, or any foreign-denominated interest incurred during any year of assessment of such trust or company must be translated into rands by applying the spot rate on the last day of that year of assessment of that trust or company.
Clarification of the exclusion of a primary residence
It is proposed that the exclusion for the acquisition of a primary residence be clarified by including funding of improvements to the primary residence and by applying the limitations in paragraph 46 relating to the land on which the primary residence is situated to the primary residence.
The proposed amendments will come into effect on 1 January 2024 and apply in respect of any amount owed by a trust or company in respect of a loan, advance, or credit provided to that trust or that company before, on or after that date.
Comments on the proposals must be submitted to Treasury’s tax policy depository at 2023AnnexCProp@treasury.gov.za and Sars at acollins@sars.gov.za by close of business on 31 August.
Click here to download the 2023 draft Taxation Laws Amendment Bill.
