The newly introduced section 7C of the Income Tax Act (“the Act”) applies to any loan, credit or advance granted directly or indirectly to a trust by, inter alia, any natural person, who is a connected person to the trust, where the loan, credit or advance is not interest-bearing or where it bears interest at a rate less than the “official rate of interest” (as defined in the Seventh Schedule to the Act).
The consequence of section 7C is that the difference between the interest rate charged and the “official rate of interest” on a loan advanced by a connected person to a trust, will be treated as a donation by the lender to the trust for that year of assessment.
Section 7C applies from 1 March 2017 in respect of any amount owed by a trust in respect of a loan, advance or credit provided to that trust before, on, or after that date.
A question that often arises is whether section 7C applies to amounts that have been vested in beneficiaries of a trust where such amounts have not yet been distributed or paid out to the beneficiaries.
SARS published an Explanatory Memorandum on 15 December 2016 (“the Explanatory Memorandum”) dealing with section 7C, which sets out National Treasury’s thinking and reasoning in regard to this question of whether loans are potentially created by means of vesting rights in beneficiaries, where such vested amounts have not been distributed to the beneficiaries.
The Explanatory Memorandum states an amount that is vested irrevocably by a trustee in a trust beneficiary and that is used or administered for the benefit of that beneficiary without distributing or paying it to that beneficiary will not qualify as a loan or credit provided by that beneficiary to that trust if:
- The vested amount may in terms of the trust deed governing that trust not be distributed to that beneficiary, e.g. before that beneficiary reaches a specific age; or
- That trustee has the sole discretion in terms of that trust deed regarding the timing of and the extent of any distribution to that beneficiary of such vested amount.
The Explanatory Memorandum goes on to state that:
An amount vested by a trust in a trust beneficiary that is not distributed to that beneficiary will, however, qualify as a loan or credit provided by that beneficiary to that trust if:
- that non-distribution results from an election exercised by that beneficiary or a request by that beneficiary that the amount not be distributed or paid over, e.g. if the beneficiary has reached the age at which a vested amount must be paid over or distributed to him and:
- The trustee accedes to a request by that beneficiary that this not be done; or
- The beneficiary enters into an agreement with the trustee in terms of which the amount may be retained in the trust.
In order to ensure that vesting amounts in beneficiaries do not inadvertently trigger the application of section 7C, it is important that the relevant trust deed be adequately worded to make it clear that the trustees have the sole, absolute and unfettered discretion to distribute or pay any income, capital profits etc. to the beneficiaries.
The non-distribution of the vested amounts to beneficiaries must not be as a result of an election exercised by the beneficiaries or requests from the beneficiaries that the amounts not be distributed or paid over. The beneficiaries should also not enter into any agreements with the trustees in terms of which they request that the vested amounts should be retained in the trust.
It is also important that the accounts of the trust reflect the amounts that have vested (but not been distributed) to the beneficiaries.
It is suggested that the vested, undistributed amounts, should be reflected under trust capital.