Low Interest rates/ Interest Free Loans to Trusts
A loan account in a trust’s financial statements can appear harmless.
No cash has been distributed. The lender has not written off the debt. The trust may not even have enough money to repay it.
Yet an annual donations-tax liability may quietly be accumulating in the background.
That is the danger of section 7C of the Income Tax Act.
The Common Trust Loan
A person may sell property, investments or shares to a trust rather than donating the assets outright.
Instead of paying immediately, the trust records the purchase price as a loan owing to the seller.
The arrangement appears simple:
- the trust owns the asset;
- the seller holds a loan claim; and
- the loan remains interest-free until the trust can repay it.
The loan itself may also undermine part of the intended asset-protection benefit. While the trust owns the transferred asset, the lender still owns the loan claim as an asset in their personal estate. That claim may remain exposed to the lender’s creditors.
Section 7C was introduced to address the tax benefit created by interest-free or low-interest funding provided to connected trusts.
How Section 7C Works
Section 7C generally applies where a natural person, or certain connected companies, provides an interest-free or low-interest loan directly or indirectly to:
- a connected trust; or
- certain companies in which a connected trust holds a significant interest.
The interest actually charged is compared with the official rate of interest.
The difference may be treated as a donation made by the lender.
This is not a once-off calculation. A deemed donation may arise every year for as long as the loan remains outstanding and bears interest below the official rate.
A Simple Example
Assume an individual sells an investment property to a family trust for R5 million, with the full purchase price remaining on an interest-free loan account.
At an official interest rate of 7.75%, the interest forgone for a full year would be:
R5 million × 7.75% = R387,500
Assuming the individual’s annual donations-tax exemption of R150,000 remains available:
R387,500 − R150,000 = R237,500
At a donations-tax rate of 20%, the potential tax would be:
R237,500 × 20% = R47,500
The official rate changes when the repurchase rate changes, so the applicable rates for the relevant periods must be used.
Donations tax is generally levied at 20%, increasing to 25% once cumulative taxable donations exceed R30 million.
Why It Is Easily Missed
Section 7C often hides in plain sight because the loan may have existed for years without an obvious cash-flow event.
The risk may be overlooked where:
- no interest has been charged;
- no money has changed hands;
- the loan is treated as an old balance-sheet item;
- the trust owns shares in the borrower company; or
- the lender assumes donations tax only applies when a loan is waived.
The absence of a cash payment does not mean that there is no tax consequence.
Trust-Owned Companies May Also Be Affected
Lending money to a company instead of directly to the trust does not automatically avoid section 7C.
The rules may extend to loans made to companies where a connected trust holds at least 20% of the equity shares or voting rights.
An interest-free shareholder or director’s loan to a trust-owned company should therefore also be reviewed.
Section 7C Has Exclusions
Not every loan falls within section 7C.
Certain exclusions may apply to qualifying arrangements involving:
- a lender’s primary residence;
- public benefit organisations;
- employee share schemes;
- vesting trusts; and
- certain commercial arrangements.
These exclusions contain detailed requirements and should not be assumed to apply merely because of how the loan is described.
The Assassin Hiding in Plain Sight
Section 7C does not require the trust to distribute cash or the lender to waive the loan.
The exposure may arise simply because a trust or trust-owned company received funding at less than the official interest rate.
An old loan account can therefore create a new deemed donation every year.
The balance may remain unchanged, but the tax consequence does not stand still.
Do You Have a Loan to a Trust or Trust-Owned Company?
Interest-free and low-interest loans should be reviewed annually rather than treated as permanent balance-sheet entries.
Book a strategy consultation with PB Consultants to assess whether section 7C applies, calculate the potential deemed donation and determine whether the loan is being treated correctly.
Disclaimer
This article provides general information only and does not constitute tax, legal, financial or estate-planning advice. Section 7C contains detailed requirements, exclusions and connected-person rules. Its application depends on the parties, ownership structure, loan terms and use of the funding. Professional advice should be obtained before changing, charging interest on, repaying or waiving a loan.
