Curb tax avoidance using trusts

A proposal by National Treasury, that aims to address the avoidance of estate duty by moving assets to a trust, could have significant tax implications for individuals involved.

The draft Taxation Laws Amendment Bill that was published for public comment in July, includes a provision that aims to make it detrimental for an individual to sell assets to a trust to which he or she is a so-called ‘connected person’ (typically family of the founder or beneficiaries of the trust) and extending a low- or interest-free loan to the vehicle.

Louis van Vuren, CEO of the Fiduciary Institute of Southern Africa (Fisa), says National Treasury has for some time held the view that South Africans move assets into trusts to avoid estate duty.

A common practice has been for individuals to sell their assets to a trust they have set up, but instead of the trust paying for the assets, the individual extends an interest-free or low-interest loan to the trust to enable the trust to finance the transaction.

Up until now, there have not been any problems with this type of structure. The common law position has always been that no loan bears interest unless interest is explicitly specified, he says.

But Treasury has argued that this makes it too easy for people to divest themselves from their assets by transferring it to a trust. This practice allows the assets to increase in value outside the estate of the original owner. When the individual eventually dies the only asset in the estate is the outstanding loan.

Van Vuren says this effectively pegs the value of the assets at the date of the sale, as there is no further growth of those assets in the estate of the founder.

“So what Treasury and the minister are saying is that this robs the State of estate duty, because those assets would have stayed in the estate and at death would potentially be susceptible or liable for estate duty,” he says.

The draft legislation proposes to curb this practice by charging income tax on deemed interest.

Should the new provisions take effect in their current form on March 1 2017 as proposed, any individual who sells assets to a trust in relation to which he or she is a connected person and finances those assets by way of a loan at an interest rate that is less than the official interest rate (currently 8% in terms of the Seventh Schedule of the Income Tax Act), will be subject to income tax on the deemed interest.

The deemed interest will be the difference between interest on the loan at 8% (the official rate) and the actual interest rate charged (in the case of an interest-free loan this will be 0%).

Thus, if an individual sells assets to the value of R10 million to a trust that he sets up and extends an interest-free loan to the trust to finance the assets, the individual will be taxed on R800 000 of deemed interest (8% of R10 million) even though this is a fictitious amount. This is the result of a proposed new section 7C of the Income Tax Act.