Trusts & Estate Planning

South Africa : Steps to curb tax avoidance using trusts could be discriminatory

By added on 09/09/2016

A proposed regulatory amendment that aims to plug tax avoidance where interest-free or low interest loans to trusts are concerned, may be discriminatory on a religious basis, an academic has argued, reports

The draft Taxation Laws Amendment Bill includes a section 7C provision that will make it disadvantageous for someone to sell assets to a trust to which he or she is a “connected person” (usually beneficiaries of the trust or family of the founder) and extending a low- or interest-free loan to the vehicle.

This has been a common way for individuals to reduce estate duty. The assets could be transferred and funded by way of an interest-free loan to the trust. The loan was then written off over time by using the R100 000 annual donations tax exemption. This allowed assets to increase in value outside the estate of the original owner. National Treasury is of the view that this could rob the state of estate duty.

According to the Davis Tax Committee, only 33% of the 333 465 active registered trusts appear to be tax compliant.

Alwyn de Koker, Professor Emeritus of Tax Law in the School of Accountancy at the University of the Witwatersrand, says in terms of Sharia Law a Muslim person is prohibited from charging interest when he advances a loan to a trust. As a result the proposed section 7C may be discriminatory on a religious basis.

Moreover, the proposed anti-avoidance measures could prove to be highly problematic.

“While the need for targeted anti-avoidance measures on trust structures is warranted in line with South Africa’s socio-economic policies, the proposed mechanism creates undue complexity.

“In fact I think that section 7C is a bit draconian and it subverts the fundamental requirements and characteristics of simplicity, equity, fairness and practicality.”

De Koker says the provision suffers from an inherent conflict and its interaction with other provisions of the Income Tax Act is troublesome.

Firstly, it targets all trusts, not simply family trusts, which may have undesirable consequences.

“There are a multitude of diverse purposes to which trusts are put into today’s legal and commercial environment and thus it may be that based on a particular set of facts, a charitable trust will also be vulnerable to the section 7C regime. The same principle applies to other trusts like those set up for minors, those set up for former spouses, commercial trusts including black economic empowerment trusts and asset protection trusts.”

In its current format it also applies to offshore trusts, which is unnecessary as a section 31 transfer pricing provision already caters for soft-interest loans to offshore trusts.

De Koker says there are also concerns about the possibility of economic double taxation and the inconsistent basis upon which the tax charge is calculated.

While it seems that National Treasury’s intention is that the new provision should be applied to new and existing loans from March 1 2017, the current wording has led some tax practitioners to believe that only new loans will be affected.

De Koker says apart from the inherent complexities and inconsistencies perhaps the most important observation is that the provision is not absolute.

“It does leave scope for planning, creative structuring and an opportunity to arbitrage inconsistencies in the legislation.”

Background to reform

South African government policy is premised on the notion of building an inclusive society and to reduce inequality by means of progressive fiscal policies.

“Now the trust as a legal institution sits ill with the concept of inclusiveness. Secondly it is perceived as an impediment to economic transformation in my opinion and thirdly it contradicts the fundamental constructs of public policy,” he says.

Moreover, the sui generis (of its own kind) nature of a trust coupled with the tax framework it is argued reduces the tax base and subverts the fundamental principle of equity on which the system of tax is ideologically based.

“Proponents of this view argue that trusts are primarily employed by affluent individuals and families to transfer wealth and avoid taxation,” De Koker explains.

He says the response by National Treasury in the form of the new proposed section 7C is an overkill as it expands the body of burdensome anti-avoidance legislation which is constructed to be punitive in nature.