Tax avoidance blow to trusts slightly softened

Treasury concedes that provision to use an income tax instrument to address estate duty and donations tax avoidance is flawed.

The initial tax avoidance blow to prevent the misuse of low interest or interest free loans to trusts as a vehicle to reduce wealth taxes – such as donations tax and estate duty – has been softened.

Several comments by organisations and individuals on the harshness of the proposed changes and the punitive effect it would have on the future use of trusts have been accepted by National Treasury.

Treasury has long considered the use of interest free loans to trusts a way to prevent paying estate duty. The loan is made to the trust to acquire an asset from the lender.

Once it becomes the trust’s asset, it is no longer part of the lender’s estate for the purpose of estate duty.

The future growth in the value of the trust assets take place in the trust and not in the lender’s estate and escapes estate duty.

The loan amount is also exempt from donations tax, as it is made in the form of a loan which requires repayment, and not a donation.

The initial draft Taxation Laws Amendment Bill wanted to add “deemed interest” on the loan to the income of the lender of the loan and charge income tax on it at a potential maximum marginal rate of 41%.

Commentators, however, said the provision to use an income tax instrument to address estate duty and donations tax avoidance was flawed.

Treasury conceded and said the deemed interest will in future be treated as an ongoing and annual donation by the lender to the trust.

Erika de Villiers, tax policy head at the South African Institute of Tax Professionals (SAIT), says the change to treat foregone interest on a loan as an annual donation is a better instrument to use.

“This means the lender will be subject to donations tax, similar to being subject to donations tax on any other donations. The lender will still be able to benefit from the R100 000 donations tax exemption.”

Treasury initially denied the use of the annual R100 000 donations tax exemption to reduce the outstanding loan amount in the first draft bill.

However, following complaints about the unfairness of the decision, and that the denial would create an “uneven playing field”, the proposal was deleted in the second batch.

De Villiers says the donations tax regime determines that 20% must be paid on the value of the donation, unless an exemption applies.

“It appears that all the donations tax exemptions that are available for other donations would also be available for these deemed donations (the interest foregone on the loan).”

If a person does not use the R100 000 exemption for anything else, the person can lend R1.25 million to the trust for the whole year without suffering donations tax. (R1.25m x 8% = R100 000).

Commentators have stated that it would be “grossly unfair” if the anti-avoidance measures applied to existing loans as this would be a retrospective amendment.

Treasury, however, said the proposed new measures were intended to apply to all loans, including those in existences before March 1 2017 when the measures will be introduced.

De Villiers says this means that an individual who made an interest free loan of R10 million to a trust in 1990 will be subject to donations tax on the deemed donation from the 2017-‘18 tax year.

The donations tax will be calculated at 20% on the 8% deemed interest (now deemed donation) on the R10 million loan, reduced by the R100 000 annual exemption.

The effect is where there had been no tax implication prior to the 2017-’18 tax year, the lender will now be subject to donations tax of R140 000. (((R10m x8%) -R100,00) x 20%)

There has been considerable criticism that the proposed anti-avoidance measures assume that all interest free or low interest loans are used to avoid estate duty or donations tax.

Commentators pointed out that trusts are also used to provide maintenance for children with disabilities, for Public Benefit Organisations and for employee share schemes.

Johann Jacobs, head of Cliffe Dekker Hofmeyr’s trusts and estates practice, says this criticism was accepted and the scope of the measures is to be narrowed to ensure that these trusts were not subjected to the anti-avoidance measures.

Treasury listed, among others, special trusts for the benefit of minors with disabilities, but did not exclude normal family trusts created for the benefit of providing for minors.

Jacobs says there is no doubt that treasury is determined to introduce measures to prevent donations tax and estate duty avoidance by using trusts.

“Where planners have been motivated primarily or solely by such considerations, the proverbial family trust may no longer be the ideal home,” he says.