Let our fiduciary experts help you decide whether interest-free loan accounts are a thing of the past.
What is a loan account?
When a person sells assets to another party without that party making immediate payment, it creates a loan account. Another way to create a loan account is for someone to lend money to another party to buy assets. The usual arrangement is that no interest is charged on the outstanding loan. For the purposes of this article we would like you to assume that the 'other party' is a South African trust.
Loan accounts have been used as a tool to reduce estate duty
The loan granted to the trust remains an asset in the estate of the lender, but it does not increase in value because the growth in the asset occurs in the trust and the loan does not attract interest. This is done to peg the value of the lender's estate for estate duty purposes.
The lender can reduce the loan each year by donating the maximum amount that an individual can donate to the trust without paying donations tax. Currently this is R100 000 per tax year. The trust can then repay R100 000 to the donor and reduce the loan due by it.
When the lender dies, the executor of his/her estate can claim repayment of the balance of the loan and may, in fact, be required to do so. This depends on how the lender bequeaths his/her estate and whether the estate has enough cash to settle the liabilities and administration costs. If repayment of the loan is claimed and the trust does not have the funds available to repay the loan, the trustees may have to sell assets held by the trust to settle the loan and this may trigger capital gains. The lender may in his/her will bequeath the loan to an heir or to the trust. Capital gains tax will not be payable on this bequest.
Proposed changes to tax legislation may stop this use of interest-free loans
In the Budget speech of February 2016 Finance Minister Pravin Gordhan indicated that people who set up and make use of trusts can expect amendments to the Income Tax and Estate Duty Acts this year. The proposed amendments will seek to stop a donor from transferring assets into a trust in ways designed to avoid estate duty and donations tax, such as the use of interest-free loans.
There have been instances in our law where an interest-free loan was taxed
In CSARS v Brummeria Renaissance (Pty) Ltd (2007 SCA) the investors in a retirement village did not compensate the taxpayer (the developer) in cash for the construction and supply of the residential units. Instead, the investors granted interest-free loans to the taxpayer in consideration for the acquisition of the life interest in the units. The Supreme Court of Appeal held that the benefit, valued against the background of a market-related interest rate, was therefore included in the taxpayer's gross income. The court, however, stressed that the right to an interest-free loan would not in all cases result in a benefit that constitutes an amount to be included in gross income.
Interpretation Note No 58 (Issue 2) confirms that the principles explained in this case would only apply in the instance where an interest-free loan is granted in exchange (quid pro quo) for goods supplied, services rendered or any other benefit granted.
The Davis Tax Committee/Taxation Laws Amendment Bill will cast more light on this.
The second interim report of the Davis Tax Committee and/or the Taxation Laws Amendment Bill due later this year will hopefully cast more light on the current situation. We hope that they will give a clear indication of the South African Revenue
Service's view on interest-free loans and if the court's decision in the Brummeria case will be confirmed or expanded.
Please contact your relationship manager to schedule an appointment with a fiduciary specialist, who will assist you with a review of your existing estate plan or create one from scratch.
DISCLAIMER The Fiduciary Focus Newsletter is intended for general information purposes only and should not be construed as tax, legal or accounting advice. This communication is based on our bona fide interpretation of legislation, rules, regulations and publications. Nedbank Private Wealth provides estate and tax planning advice; however, we do not provide tax, legal or accounting advice and you are requested to consult a professional tax advisor or professional in this regard.
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