To further clamp down on the use of trusts for tax avoidance, section 7C of the Income Tax Act 58 of 1962 (“ITA”) was introduced to curb the tax-free transfer of wealth by using interest-free or low-interest loans to trusts. The section has since been repeatedly amended to expand the ambit and to close structuring opportunities. National Treasury has yet again proposed certain amendments to section 7C in the 2024 Draft Taxation Laws Amendment Bill (“TLAB”), this time focusing on the exclusion available where the transfer pricing (“TP”) provisions apply.
Section 7C targets the situation where a person makes an interest-free or low-interest loan, advance or credit arrangement to a trust. The provision also applies to cross-border loan transactions and deems the foregone interest on the loan to be a continual donation, such that the lender will be liable for donations tax on the difference between the interest rate charged and the official rate of interest as defined (currently 9.25% for ZAR denominated debts).
Section 7C(5) lists scenarios where section 7C does not apply. Specifically, paragraph (e) provides that section 7C shall not apply in circumstances where the TP provisions in section 31 of the ITA apply to a cross-border loan or advance made by a South African resident to a non-resident, including where a South African resident, as a beneficiary of a foreign trust, loans money to that trust. Due to the wording used in section 7C(5)(e), there has been an ongoing debate about how sections 7C and 31 interact, with the majority view being that section 7C would not at all apply to a loan where the provisions of section 31 apply.
Per the 2024 budget announcement, the issue in question is that the section 7C(5)(e) exclusion does not effectively address the interaction between the trust anti-avoidance measures and the TP rules in circumstances where the arm’s length interest rate is less than the official rate on these cross-border loan arrangements. This can create a structuring opportunity that could lead to the erosion of the tax base.
The 2024 draft TLAB proposes that a legislative amendment be made to ensure that section 7C(5)(e) will only extend to the interest which is subject to a TP adjustment. The balance of interest up to the official rate of interest will be subject to section 7C and will be deemed to be a donation made by the lender and subjected to donations tax.
If enacted, the proposed amendment will come into operation on 1 January 2025.
SARS and National Treasury are intent on closing any loopholes in the tax legislation that may allow taxpayers to avoid or reduce their tax liabilities through the use of trusts. Taxpayers should seek proper advice to ensure that their structures are fully compliant with the relevant tax provisions. Failure to do so may result in significant tax consequences and penalties in future.
If you wish to discuss these topics, please contact:
WTS Renmer
