Time for an advance ruling?

The general rule under s 7C of the Income Tax Act is that a loan, advance or provision of credit by a natural person to a trust (or company) to which the lender is ‘connected’ (for example, a beneficiary) at a soft rate is subject to the donations tax.

Exemption
Exemptions are provided in s 7C(5). My interpretation of s 7C(5)(b) is that it applies only to a vested-rights trust, as distinct from a discretionary trust, the latter being the usual estate-freezing trust type. (See, especially, s 7C(5)(b)(i), which refers to the beneficiaries holding in aggregate ‘all the receipts and accruals and assets of that trust’.

Thus, if the loan accounts relate only to a portion of the trust funds and the beneficiaries in aggregate do not hold a vested interest in the entire trust fund, the exemption does not apply.

A sui generis exception?
Some prominent tax practitioners hold the view that a loan or advance does not arise in circumstances in which trustees vest an award of the trust fund but do not pay it out to a beneficiary. (Usually the vesting is designed to exploit para 80 of the Eighth Schedule to the act, under which the conduit principle is applied to a realized capital gain, resulting in a lower rate of CGT in the hands of a beneficiary who is a natural person than the rate applicable to the trust.)

It is argued that a vested right remaining unpaid is not categorized as a ‘loan advance or credit’, as is required by s 7C(1).
The first argument in support of this view (as I understand it) is that a loan, advance or credit requires an agreement, which is absent. In my view, once trustees have vested an award, there is an implied understanding, or arrangement (hence an agreement) that the beneficiary has a loan claim.

The second and more persuasive argument is that, if the trust deed is amended to provide for awards to remain unpaid, the deed will accord with the Explanatory Memorandum published by the Treasury on 15 December 2016 which states that no loan, advance or credit arises when ‘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’.

Many accountants thus record this transaction as a liability of the trust, being an accrued but unpaid award.My concern, however (leaving aside the weight to be accorded an explanatory memorandum), is that, if a beneficiary has received a previous award, the beneficiary is required to be a party to future amendments of the deed  (CIR v Estate CP Crewe and Another 1943 AD; Crookes NO and Another v Watson and Others 1956 (1) SA 277 (A)).

This is consequently a bilateral agreement between the trustees and beneficiary, under which the beneficiary agrees not to demand payment upon vesting of an award. In my view, it could be straining the meaning of the exception mentioned in the Explanatory Memorandum, given the conclusion that it is a bilateral and not the unilateral decision of the trustees pertaining to future awards.
Maybe it is time for an advance tax ruling.

[This topic was covered extensively in 179 TSH 2018. For the rights of beneficiaries in relation to amendments, see 156 TSH 2016, 169 TSH 2017. See also my Reflections on a Specimen Trust Deed—Ed]