Interest free loans or low interest loans to trusts and related companies – sec 7C revisited.
In our circular dated the 10th of January 2017 we discussed the newly introduced Section 7C of the Income Tax Act, which has since been promulgated into law. We made the following statement:
It seems from the wording that an interest free loans or low interest loans to a company, even if the trust owns all the shares, will not fall foul of these provisions. As legislation stands at the moment, this seems to create an opportunity to circumvent the provisions of Section 7C.
Unfortunately and, in our opinion, due to a variety of avoidance schemes utilised by certain practitioners in order to circumvent Section 7C, it was announced in the 2017 Budget Speech that Section 7C will be amended to include interest free loans or low interest loans to companies owned by a trust.
The Draft Taxation Laws Amendment Bill, 2017, which is still open for comments, contains the following amendments to Section 7C:
Section 7C (a) has been redrafted to include a loan, advance or credit made by:
- a natural person; or
- at the instance of that person, a company in relation to which that person is a connected person in terms of paragraph (d)(iv) of the definition of connected person,
- trust in relation to which-
- (aa) that person or company, or
- (bb) any person that is a connected person in relation to the person or company referred to in item (aa),
- to a company that is a connected person to the trust referred to in subparagraph (i) of this section.
With reference to the explanation contained in the Explanatory Memorandum to the Bill, it is clear that there must have been an oversight in the wording of the new paragraph 7C(1)(b)(ii). As the paragraph stands at the moment, and due to the very wide definition of “connected person” in the Income Tax Act, even a loan to a company that has nothing to do with a trust can fall under Section 7C due to the fact that, for instance, the sole director of the company is also a beneficiary of a trust. Clearly this could not have been the intention of the legislator and we are confident that subparagraph (ii) will be amended to refer to a loan to a company that is a connected person as envisaged in paragraph (d)(iv) of the definition of connected person, to the trust referred to in subparagraph (1)(b)(i).
That would mean that only a company where the trust individually, or jointly with any connected person in relation to the trust, holds directly or indirectly at least 20% of the company’s equity share capital or voting rights, will fall foul of these provisions.
To counter certain further avoidance schemes a new subsection (1A) was introduced stating that:
- If a natural person acquires a claim to an amount owing by a trust or a company in respect of a loan, advance or credit referred to in subsection (1), that person must for purposes of this section be treated as having provided a loan, advance or credit to that trust or company –
- On the date on which the person acquired that claim; or
- If that person was not a connected person on that date in relation to-
- that trust; or
- the person who provided that loan, advance or credit to that trust or company, on the date on which that person became a connected person in relation to that trust or person, that is equal to the amount of the claim so acquired.
This was brought into the act to counter certain avoidance schemes where a person, who made a loan to a trust, entered into an arrangement in terms of which the claim for the loan against the trust is transferred to another natural person (i.e. a beneficiary of the trust) in order to try and ensure that the link between the natural person who advanced the loan and the loan itself is severed.
Certain other subsections were amended to provide for the inclusion of loans to a company as mentioned above.
A new sub section 5(h) was added providing exemption from the provisions of Section 7C to a trust that was created solely for purposes of giving effect to an employee share incentive scheme under certain circumstances and provided that a person who is a connected person in terms of paragraph (d)(iv) of the definition of connected person in relation to any scheme company would not be entitled to participate in that scheme.
These amendments will come into effect on the 19th July 2017 and will apply in respect of any amount owed by a trust or a company as envisaged in respect of a loan, advance or credit provided to that trust or that company before, on or after that date.
The provisions of sub section 5(h) (employment share incentive trust) is deemed to have come into operation on 1 March 2017 and applies in respect of any amount owed by a trust in respect of a loan, advance or credit provided to that trust before, on or after that date.
A new Section 7D has been introduced, providing that:
Where it must be determined what amount would have been incurred as interest in respect of any loan, debt, advance or amount of credit provided to a person or an amount owed by a person had that interest been incurred at the official rate of interest, that amount must be determined without regard to any rule of the common law or provision of any act in terms of which –
- the amount of interest, fee or similar finance charge that accrues or is incurred in respect of a debt may not in aggregate exceed the amount of that debt; or
- no interest may accrue or be incurred in respect of a debt once the amount that has accrued or been incurred as interest is equal to the amount of that debt.
These measures are aimed at invalidating the effect of the in duplum rule in common law which basically states that the amount of interest recoverable from a debtor could never exceed the capital amount of the debt.
This section comes into operation on 1 January 2018 and applies in respect of years of assessment ending on or after that date.
- While the result of the amendments are unfortunate, it had to be expected. We again wish to stress the importance of clients contacting their advisors regarding any trusts or affected companies where loans, as envisaged above exist
Even if amended as suggested above, the provisions are still very wide.
A and four of his cousins (whether on both sides of the family or not) form a company for a business venture and fund the company with interest free loans.
As long as they are the shareholders, Section 7C will not apply. Should one of them decide to transfer his shares to a trust of which he is a beneficiary (or of which a connected person in relation to him is a beneficiary), Section 7C will apply to all loans to the company. Cousins are connected persons, and for that reason all the shareholders are connected persons in relation to the trust. They are shareholders of the company and as such, connected persons in relation to the company.
I do not think that this could have been the intention but, at the moment, it is the result.
- This is a further chapter in the trust saga and will have an effect on the use of trusts. However, with careful planning by knowledgeable advisors it would still be possible to utilise the trust as a useful estate planning vehicle
- Please note that this is still draft legislation open for comments. Further changes might and most probably will occur to the final bill being accepted by parliament.
- We will inform you on any further development
GPJ van den Berg
Delport van den Berg
Estate and Trust Services (Pty) Ltd
T: +27 (12) 361 5001