In this year’s budget, Minister Gordon made certain proposed changes, particularly relating to assets introduced to trusts on loan account. These proposals appeared, at the time, to be largely impractical. However the topic has resurfaced with the issue of the Taxation Laws Amendment Bill last month. It is important to remember that this bill is not law and is likely to be strongly protested. However it is this writer’s opinion that these proposals, although unfair in many ways, are at least practically enforceable, unlike many of the previous proposed changes.
So what are the changes that have been proposed? Essentially the legislation proposes:
- That assets that are introduced (or sold) to a trust on loan account by a natural person (or entity connected to that natural person), and
- That are interest-free or bear interest at less than the interest rate prescribed by SARS at the time,
- Will be deemed to be income in the hands of the lender. Essentially the lender will receive deemed interest that will be taxed in his or her hands. However this interest will not be tax deductible by the trust.
The legislation further goes on to say that the lender may recover any tax paid or payable on the deemed income from the trust. If the lender does not do so within three years, the amount of tax not so reclaimed will be deemed to be a donation received by the lender and the trust will be subject to donations tax at 20%.
From the above it can be seen that such a transaction attracts tax from two directions. Practically this could spell the end of the use of trusts for assets that do not earn any income or where those assets earn income which is exempt from income tax. For example, if a holiday home is sold to the trust on an interest-free loan account, it will not have any income on which to pay the lender interest. The lender will then be taxed on this deemed interest income. The trust will not be able to pay the tax that the lender is entitled to recover, thus leading to further donations tax. Because the trust does not have the funds to pay the donations tax, further money will need to be lent to the trust in order to allow it to do so, thus exacerbating the cycle.
The proposed changes are truly significant and could spell the end of the use of family trusts. One hopes that common sense will prevail and that Treasury will realise that trusts have other benefits, such as protecting family assets against business liabilities. Only time will tell whether the objections, that are surely likely be made against this legislation, will be successful.