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Interest free loans to trust – not so free anymore?

By Sisteen Geyser

If a Trust owes you money on loan account and the loan is interest free, or the interest rate charged on the loan is below the official rate of interest (currently 8%), you will be liable for donations tax on the deemed interest on the loan from 1 March 2017.

The new tax legislation was imposed to reduce the use of trusts in estate planning which traditionally has the effect of reducing estate duty and donations tax.

Sec 7C of the Income Tax Act is applicable to all interest free or low interest loans (affected loans), including loans in existence, made to a trust directly or indirectly by a natural person, or company that is a connected person in relation to that natural person, and means the interest foregone will be treated as an ongoing and annual donation made to the trust.

Typically, this will be applicable where a person sold an asset to a trust on loan account at a rate lower than the official rate, and/or where the trustees of a trust made a distribution to trust beneficiaries and the beneficiaries loaned the money back to the trust.

There are a few exceptions to this rule:

  • A loan made to a Trust that was used to buy a residence that is used by the lender or the lender’s spouse as a primary residence.
  • Loans to Special Trusts that are created solely for the benefit of minors with disabilities.
  • A loan by a trust beneficiary to a trust that qualifies as a bewind trust, i.e. a trust that holds and administers assets, the ownership of which vests in that beneficiary, for and on behalf that beneficiary.
  • Loans to Public Benefit Organisations Trusts.
  • Depending on the exact terms of the Trust Deed, some loan accounts in respect of distributions to beneficiaries may also not be subject to the deemed donation tax.

The common practice of reducing the lender’s taxable assets by cancelling or waiving the loan to the trust has also been affected by the legislation, which now provides that no deduction, loss, allowance or capital loss may be claimed in respect of interest free loans or low interest loans made to trusts.

However, the annual Donations Tax exemption of R 100 000 will still apply to the deemed donation in terms of Sec 7C, so that donations tax will not be payable if the deemed interest on the loan is less than R 100 000 per year.

Should you have such an affected loan account with a trust, we urge you to contact our Trust and Estate Planning Department. We can check the trust deed and the way in which existing loan accounts came about; and advise on how distributions to the beneficiaries should in future be made, in order to reduce the adverse effects of this new legislation.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)