TRUSTS, PREFERENCE SHARES AND SECTION 7C – NO GOOD DEED GOES UNPUNISHED
Trusts continue to play an important role as estate planning and asset protection vehicles. Traditionally, individuals would seek to limit the accumulation of value in their personal capacities by granting low interest or interest free loans to the trust. The trust would acquire the trust assets and would thus benefit from the growth in the value of such assets, whilst the liabilities of the trust would be diminished by inflation.
With the introduction of section 7C of the Income Tax Act in 2016, low interest and interest free loans were brought within the ambit of the donations tax regime. In broad terms, to the extent that the rate of interest charged on certain loans falls below the SARS ‘official rate’, the short-charged interest is deemed to be a donation and may be subject to donations tax at a rate of 20%.
Subsequent amendments extended the ambit of section 7C to certain loans made to trust-held companies. However, preference shares escaped the provisions of section 7C and thus left taxpayers with a relatively simple mechanism to achieve the same economic outcome without triggering any adverse implications under section 7C (e.g. instead of advancing an interest free loan to a trust or a company owned by a trust, the individual could simply subscribe for zero coupon shares).
The 2020 Draft Taxation Laws Amendment Bill seeks to expand the scope of section 7C on the basis that the subscription consideration received by a company for the issue of ‘preference shares’ would be deemed to be a loan for purposes of section 7C.
The proposed amendment will come into operation on 1 January 2021 and will apply in respect of years of assessment commencing on or after that date. It appears likely that the wording of the amendment will undergo further refinement prior to promulgation and taxpayers would be well advised to approach trust formation and funding structures with caution.
Contact us should you wish to better understand the proposed amendment and how it may impact you.
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