Explaining the Tax Implications of Section 7C for Trusts in South Africa

Introduction

Trusts are a popular tool for estate and asset protection in South Africa. However, with the introduction of Section 7C in 2017, there are important tax implications to consider. This article explores these changes and what they mean for trust management.

Understanding Trusts

Definition: A trust is a legal arrangement where a trustee manages assets on behalf of beneficiaries.
Objective: To provide long-term benefit for beneficiaries and embed the founder's values into the trust.
Role of Trustees: Guardians of the founder's values, ensuring stability and continuity.

Pre-Section 7C: The Loophole

Common Practice: Assets were transferred to trusts via interest-free loans, reducing taxable estates.
Benefit: Avoided estate duties and donations tax.

The Impact of Section 7C

Purpose: To close the loophole of interest-free or low-interest loans made to trusts.
Mechanism: Forgone interest is deemed a donation, subject to donations tax.
Goal: Ensure fiscal responsibility by curbing the use of trusts to avoid taxes.

Implications for Taxpayers

Increased Complexity: Potential tax liabilities for using interest-free or low-interest loans.
Deemed Donation: Forgone interest is taxed at 20% up to ZAR 30 million, and 25% for amounts exceeding ZAR 30 million.
Compliance: Review trust structures and loan agreements to avoid unexpected taxes.

How Section 7C Works: Examples

Example 1: Interest-Free Loan

• Scenario: Mr. Smith loans ZAR 1 million interest-free to a trust.
• Calculation: Deemed interest = ZAR 92,500 (1,000,000 * 9.25%)
• Tax: ZAR 92,500 treated as a donation, taxed accordingly.

Example 2: Low-Interest Loan

• Scenario: Mrs. Jones loans ZAR 2 million to her family trust at 2% interest.
• Calculation: Interest difference = ZAR 145,000 (2,000,000 * (9.25% - 2%))
• Tax: ZAR 145,000 treated as a donation, taxed accordingly.

Taxation of Trust Distributions

Return of Capital: Generally not subject to income tax for the beneficiary. Keep accurate records.
Loan Repayments: Not subject to income tax as they return the principal amount. Interest earned is taxable.

Costs of Maintaining a Trust

Professional Fees: Range from R20,000 to R100,000 per trust per annum, excluding VAT.

Conclusion

Section 7C significantly impacts how trusts operate, especially regarding loans. Taxpayers and financial planners must adapt their strategies to comply with these regulations. Understanding Section 7C is crucial for effective trust management and taxation.

Written by Stefanie Greyling, Principal and Licence Partner at Engel & Völkers Knysna