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Section 7C: how does SARS interpret it? · Tax Break: South African tax for professionals

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  Section 7C has been our topic for tax practitioners since it
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  was introduced into the Income Tax Act as part of the 2016
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  amendments. Now it's one of those few
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  sections that as soon as you mention the section number, most
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  people would know what you are talking about.
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  Now Sasha issued the draft interpretation note for comment
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  on this provision light in November last year and it's
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  already closed for comment now. Although it's only in a draft
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  format, we can get some insight into Sasha's thinking approach
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  or how they interpret this provision.
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  So you're listening to the Tax Break Podcast, the podcast for
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  South African tax professionals and tax practitioners.
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  And today we are looking at some of the aspects that such
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  addressed in this draft interpretation.
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  Note, as always, before we start, I would like to ask you
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  to rate the podcast on your favorite podcast platform.
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  to the podcast to them. And then just a reminder, if you
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  want to correspond with me, whether it's questions, ideas,
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  or if you need some tax advice, my e-mail address is in the
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  notes to the episode, right? So let's talk about Section 7C.
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  And I would like to start off by just talking about what it is in
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  a nutshell. And I think we can't really talk
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  about the provision without looking at why it was
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  introduced. So if we think about estate
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  planning, if an asset is is is owned by an individual, that
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  ACID would form part of the state of the individual and
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  would be subject to a state duty when the individual passes away.
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  Whereas if the asset is owned by it within another structure,
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  something like a trust for example, then the acid shouldn't
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  form part of the estate of the individual when that person
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  passes away. Now the trick with estate duties
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  to to be able to get the asset to the trust in, in, in in a tax
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  efficient manner. Now you can, the individual can
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  donate the asset to the trust. Then you would have capital
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  gains tax on the disposal of the asset.
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  Plus you would also have donation stacks on the value
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  that was donated to the trust. And that's normally marry a
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  course that's too high for for many people doing good to to
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  move the acid into the into a trust.
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  Now the alternative to that to is to sell the asset to the
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  trust. So you still have the capital
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  gains tax on the disposal, but because you you retain a loan
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  claim against the trust, you don't have the donations tax.
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  And the benefit of selling the asset to do they state or do the
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  trust without charging interest on the loan is that you've
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  essentially frozen the value of the estate for estate duty
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  purposes. Now it's exactly this practice
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  that section 7C was introduced to curb.
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  So what Section 7C now says is that if there is a learn from an
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  individual to a trust then and that that that that loan does
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  not pay interest at the official rate, the difference between
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  what the interest at the official rate would have been
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  laced. The interest that you are
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  actually charging on this loan is deemed on an annual basis to
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  be a donation to by the individual.
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  And that donation would of course then be subject to
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  donation stacks. Now if we look at the scope of
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  Section 7C, it doesn't only apply to loans from the
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  individual to the trust. It also applies to to loans made
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  to companies that where the shares of those companies are
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  owned by the trust. So in other words, it's
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  basically any the trust and all the companies that that that
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  above a certain threshold where the trust owns the shares of
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  those companies. It's also important that on the
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  on the lender side, the individual side, that it's not
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  only alone by the individual, but it's also a loan by a
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  company that's connected person to the individual at the
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  instance of that natural person to the trust or the company that
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  sits below the trust. And then maybe I think the last
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  aspect that is sort of in my mind part of the core of what
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  Section 7C is all about is that one of the ways in which
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  taxpayers then structured their face to do not fall within the
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  balance of Section 7C was to fund the the company that's
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  owned by the trust using preferences instead of a loan.
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  And Section 7C has been amended subsequently to also deem those
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  preference shares to be loans for purposes of Section 7C.
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  OK. So I think that's in a nutshell
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  the the key aspects of Section 7C.
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  Then I would like to move on to point out a few things that we
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  can gather from the draft interpretation note.
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  So I've identified 4 things. The first one is that such
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  indicates that the interest that you need to calculate.
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  So in other words, what the interest at the official rate
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  would have been. That is simple interest on the
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  balance of the loan. So there is no compounding or
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  anything like that. The calculation is simply the
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  balance of the loan multiplied by the interest rate.
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  The second aspect that they that they point out is that the the
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  focus of section 7C is on the lender.
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  Now remember section 7C deems a donation to to to have been made
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  and residents are subject to donations tax.
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  So if the lender is a resident, this individual making the loan
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  or those instance the loan has been has been made, then section
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  7C comes into play. What's also important about the
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  if we look at the cross-border side, so if the lender is
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  resident, irrespective of whether the borrower is a
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  resident or not, 7 C would is something that you need to
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  consider now in a cross-border context.
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  There was an amendment recently to make it clear that even if
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  you've made a transfer pricing adjustment up to what the arms
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  length interest would have been, if this arm's length interest is
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  something less than the official right, Section 7C would still
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  apply to the difference between that arm's length interest and
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  the official right. So you would have a a top up tax
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  even though you are the the interest has been adjusted to
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  the official to the arms length right?
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  You could still have a 7 see effect if that ARM sling threat
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  is less than the official, right.
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  The third aspect that I would like to highlight and that's now
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  specifically to do with loans made by companies connected to
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  natural persons where the loan is made at the instance of the
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  natural person. So then there would be a
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  donations tax effect for the natural person at whose instance
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  Stallone has been advanced. Now SASH provides some of the
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  interpretation as to what it means for a loan to be advanced
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  at the instance of a person. So they're saying that if the
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  person suggested or instigated the loan, then they are of the
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  view that it was done at the, the loan was made at the
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  instance of this person. Now there could be some
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  scenarios where if you, if you look at the the detailed wording
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  of Section 7C, you've got parallel trust structures.
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  So trust 2 trusts with companies below them and these companies
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  lend money to each other. And I think there are some
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  scenarios, especially if the natural person is the only
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  director of the lender company with I think there could be an
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  argument that Section 7 see that that that scenario falls into
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  the wording of Section 7C, although it's money, its value
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  being shifted between trusts essentially not from the
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  individual to to the trust. Now interesting is that Sash
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  mentions in the in in the draft interpretation.
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  Note that underlying to this concept of loans being advanced
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  at the instance of a of a natural person is that this
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  should result in a wealth transfer from the person to the
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  trust. So there might be something in
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  the case of these parallel trust structures do that they there
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  could be something in this that could help you to formulate the
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  view that Section 70 should perhaps not apply they seeing
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  that there is no wealth transfer from the person to the trust.
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  However, one has to keep in mind that you still need to work with
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  the actual wording of the legislation.
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  The 4th point that I would like to point out in the last one,
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  ohh, today is that, and it specifically relates to a
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  scenario. It's, it's been something that's
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  been contentious since the introduction of Section 7C,
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  where a trustee makes a decision to waste an amount in a
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  beneficiary of a trust, but instead of paying that amount to
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  the beneficiary, the amount remains outstanding on the loan
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  account. So in other words, we're back
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  into the realms of Section 7C because we've got an amount
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  owing by the trust to an individual.
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  Now, Section 7 C one of the requirements is that the
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  individual must have granted or advanced or provided the loan to
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  the trust or the the entity under the trust.
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  So what Zach indicates in the draft interpretation note is
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  that the the word or the phrase to provide implies A conscious
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  decision rather than just merely mere acquiescence to say.
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  But it's something that happens and you have to accept it.
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  So what I think we can take from this is that you need to look at
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  the facts and circumstances very carefully to see.
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  But was there a concert, a conscious decision by the
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  beneficiary to make this money available to the to the trust?
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  That could be an election by the the beneficiary to, to keep the
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  wasted amount outstanding on loan account.
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  I suggestion by the beneficiary to do it in this way or
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  agreeance by the beneficiary in this way.
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  If it's just the trustees telling the beneficiary this is
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  how it's going to be, I think they there's probably a good
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  case thing to be made that the loan was not provided by the
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  beneficiary. OK, What are the takeaways from
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  this? This this episode 1 is the draft
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  interpretation note. It gives us a bit of guidance on
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  how to do the calculation of the interest.
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  It also provides us with clarity as to where the focus of Section
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  70 is being on the lender as the person who would be deemed to
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  make this donation. It provides us with some insight
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  into what it means for a loan to be made at the instance of the
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  natural person. And then it also highlights some
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  of the answers that may arise in the context of trusts wasting
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  amounts to beneficiaries online account.
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  That's it for today's episode. Just reminder, as always,
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  nothing in this episode is intended to be tax advice or
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  replacement for tax advice. Until next time, goodbye.