National Treasury has substantially softened its proposal to end interest-free loans to trusts that can be repaid or written off over a number of years, resulting in an estate duty and donations tax saving for those who make use of these loans.
An initial draft of the Taxation Laws Amendment Bill released in July proposed that, from March next year, if you make an interest-free loan to a trust, you would be deemed to have received interest at the official interest rate, and this interest would be added to your taxable income.
In the case of a low-interest loan, the difference between the interest charged and the official interest rate would be added to your income.
The official interest rate is currently eight percent a year.
Treasury also proposed in its initial draft bill that you would not be able to use the R100 000 annual donations tax exemption to write down up to R100 000 of a loan made to a trust each year.
When the proposal was first made, David Warneke, the head of tax technical at BDO South Africa, warned that it could result in trusts being wound up.
In a response document published on its website this week, Treasury says that commentators pointed out that the measures to stop interest-free and low-interest loans were aimed at preventing the avoidance of donations tax, not income tax. It has therefore decided that the deemed interest should be treated as an annual donation.
A second draft bill, which was released for comment this week, has been amended to reflect that the deemed interest will be treated as an ongoing donation with effect from March next year.
Treasury has also backtracked on its decision to deny those who make loans to trusts the right to use the annual donations tax exemption to write down the loan. This was in response to comments that this proposal would affect all loans made to trusts, not only low-interest or interest-free loans.
In terms of the second draft bill, you will be able to use the R100 000 annual donations tax exemption to offset donations to a trust, but you will have to include the deemed interest on the remaining loan in the R100 000, or it will be regarded as a taxable donation.
It is common practice for people who want to place an asset worth more than R100 000 in a trust not to donate the asset to the trust, because they would be liable for donations tax at a rate of 20 percent on the value of the asset that exceeds the annual exemption of R100 000. Instead, they make an interest-free loan to the trust so that the trust can buy the asset. They then write down R100 000 of the loan each year as a donation to the trust.
This also enables them to reduce their estate duty liability by pegging the value of their estate to the value of the loan account. Growth in the value of the asset will occur in the trust. This can result in a saving on estate duty if their estate is valued at more than the estate duty exemption of R3.5 million, or R7 million per couple.
In comments on the initial proposal, tax practitioners and other interested parties pointed out that trusts are not only used to avoid estate duty, but also to provide maintenance for children with disabilities, for pubic benefit organisations (PBOs) that do charitable work, as employee incentive trusts, by business-people who want to protect their personal assets from business creditors, or to protect assets from a delinquent child who would otherwise squander them.
Treasury accepted that these comments were valid and said it would narrow the application of the proposed amendment to ensure that it will specifically exclude, among others, loans to:
• Special trusts that are established solely for the benefit of persons with disabilities;
• Trusts that are PBOs as defined by law;
• Vesting trusts (where the vesting rights and contributions of the beneficiaries are clearly established);
• A trust to fund the purchase of the lender’s primary residence; and
• A trust that provides for a sharia-compliant financing arrangement.
Tax practitioners also commented that it was not clear whether the draft bill applied to loans made to existing trusts, and that if it did, this would be unfair, because people who wanted to unwind these trusts would incur capital gains tax when the assets in the trust were sold. Treasury did notaccept this argument, saying the proposed provision would apply to existing loans.