Tax proposals affecting trusts

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By Pieter van der Zwan

The National Treasury published the draft Taxation Laws Amendment Bill (TLAB) for 2017 on 19 July 2017. This article considers two aspects of proposals in the bill that are likely to have a significant impact on trusts.

Amendments to section 7C

Section 7C is an anti-avoidance provision that was introduced into the Income Tax Act with effect from 1 March 2017. The provision is aimed at transactions used to fund trusts in which wealth accumulates outside an individual’s estate. Such growth could escape estate duty. It applies where a loan, advance or credit has been provided by a natural person or connected company, at the instance of the natural person, to a connected trust. If this loan, advance or credit does not bear interest at a rate at least equal to the repurchase rate plus 1%, s 7C deems, on an annual basis, the shortfall in interest to be a donation that attracts donations tax.

The draft TLAB proposes to expand the scope of s 7C to also apply to a loan, advance or credit provided by the natural person (or connected company, at the instance of the natural person) to any company, which is a connected person in relation to the above trust. It is submitted that this proposal widens the scope of s 7C significantly, possibly beyond the intended purpose of the provision. For instance, a company would be a connected person in relation to a trust merely by reason of the fact that a natural person who holds all the shares of the company, is a beneficiary of the trust. The current proposal would arguably bring a loan from the natural person to this company within the scope of s 7C, even though no estate duty avoidance risk exists.

Amendments to controlled foreign company rules

A foreign company is a controlled foreign company (CFC) if more than 50% of its participation rights or voting rights are held, directly or indirectly, by South African residents. The consequence of being a CFC is that some of the foreign company’s profits may be imputed into the hands of residents who hold participation rights in that company.

A number of structures exist where shares of foreign companies are held by a foreign trust, often a discretionary trust, where South African residents are beneficiaries of such trust. It is argued that these foreign companies are not CFCs as South African residents do not hold any vested right in participation rights or voting rights.

An amendment is proposed to the definition of CFC to include the above structures within the CFC regime. It is proposed that where a trust or foundation, directly or indirectly, holds more than 50% of the participation rights of voting rights of a foreign company, and one or more residents hold an interest in such trust or foundation, the foreign company will be classified as a CFC.

As the resident beneficiaries may not have vested rights, imputation of CFC profits to specific persons is problematic. A further proposed amendment is that any amount distributed to a South African beneficiary (other than a company) by a foreign trust or foundation that holds a participation right in a foreign company, which would have been a CFC had the trust or foundation been a resident, must be included in the resident beneficiary’s income. It appears as if this proposed inclusion in income is regardless of the connection to the foreign company or the nature of the amount so received.

In conclusion

The TLAB is still open for comment. The content of the final amendments may differ from the proposed version. Taxpayers and advisors should keep a close eye on the developments over the next few months.