From 1 March 2017 onwards, taxpayers have a further consideration in the form of section 7C of the Income Tax Act to take into account when doing estate planning. This provision deals with loans advanced by or at the instance of a natural person to a trust to which that person is connected. This provision may require a careful consideration of the overall benefits, including tax benefits, of housing certain assets in a trust as there may be a recurring tax cost associated to this decision.
Housing wealth in a trust may be advantageous from a tax perspective for a number of reasons. This includes that, if properly managed and set up, the assets held by the trust do not form part of the taxpayer's estate for purposes of estate duty. It may also provide an opportunity to distribute income between beneficiaries in whose hands it is taxed.
The initial transfer of an asset to a trust may have tax implications in the form of donations tax, capital gains tax as well as transfer taxes (for example, transfer duties on fixed properties). The donations tax implication could generally be avoided by selling the assets to the trust on an interest-free loan account as opposed to donating it. At the same time this mechanism froze the value of the estate at the selling price. This mechanism may however trigger another layer of tax in light of the new section 7C of the Income Tax Act going forward.
Section 7C in a nutshell
This provision applies to any loan, advance or credit provided by a natural person, or connected company at the instance of the natural person, to a trust to which such natural person, company or their connected persons are connected. This would essentially mean that a loan advanced to a trust by a person where such person or the person's family members are beneficiaries would be within the scope of this provision.
If such a loan does not bear interest or bears interest at a rate lower than the official rate of interest (being the repurchase rate plus 1%), the difference between the interest charged (if any) and the interest that would have been charged at the official rate is deemed to be a donation by the natural person to the trust at the end of the trust's year of assessment. This deemed donation is subject to donations tax at a rate of 20%. The annual donations tax exemption available to natural persons may be utilised against this donation. This provision will apply to both new and existing loans in place from 1 March 2017.
Practical considerations from this development
In consequence of the introduction of section 7C, taxpayers and their advisors would need to:
- Identify loans in existing trust structures that are potentially affected by the provisions, including loans arising from distributions.
- Consider whether any of the exclusions from the provision may be applicable in the particular taxpayer's circumstances. It is important to bear in mind that some of these exclusions exist due to the fact that the transaction may have other tax implications.
- Determine whether the taxpayer and/or trust can fund the additional tax cost of maintaining an interest-free loan structure as well as the impact of this cost on accumulated wealth in the longrun. The alternative of charging interest on this loan brings its own tax implications and impact on any estate planning undertaken.
- Review existing trust asset holding structures and revise it if this is no longer the most efficient tax or commercial structure.
It is submitted that this development may prompt taxpayers to rethink the nature of assets transferred into trusts, the rationale for transferring assets into trust and the way that such trusts should be set up going forward.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.