And more on s 7C of the Income Tax Act
In 168 TSH 2017, I examined the interaction between the various sections of the Income Tax Act pertaining to resident funders of nonresident trusts. It is time to revisit this topic.
Attribution rules (s 7(8))
Section 7(8) provides that when a resident makes a donation, settlement or other disposition (including a soft loan) to a nonresident entity, including a trust, any taxable income causally accruing to the nonresident is attributable to the resident. In similar vein, para 72 of the Eighth Schedule to the Act attributes capital gains of the non-resident to the resident.
Soft loans (s 31)
Section 31 seeks to inhibit tax avoidance by way of the giving of financial assistance (an ‘affected transaction’) to a nonresident entity, in circumstances in which the transaction is not concluded at arm’s length. A soft loan made by a resident to a nonresident trust would be included.
Although not specifically required by s 31, a determination of a market-related, arm’s-length rate should presumably have regard to the ‘official rate of interest’, as the term is defined in s 1(1):
(a) In the case of a debt which is denominated in the currency of the Republic, a rate of interest equal to the South African repurchase rate plus 100 basis points; or
(b) In the case of a debt which is denominated in any other currency, a rate of interest that is the equivalent of the South African repurchase rate applicable in that currency plus 100 basis points.
Fair administrative action and double taxation
The advent of the Constitution in 1994, including the right to fair and just administrative action under the Bill of Rights, means that the decisions of SARS can be reviewed by the judiciary, on the basis of unreasonableness, with the Tax Administration Act potentially providing remedies first to be exhausted.
It follows that SARS cannot impose double taxation on the same taxpayer (CIR v Peoples Stores (Walvis Bay) (Pty) Ltd) 52 SATC 9), and the cases there cited), both under s 7(8) and para 72, and under s 31.
It follows that a resident lender can choose the application of either s 7(8) and para 72, or, alternatively, s 31.
Under the s 7(8) and para 72 option, income arising in the nonresident trust will be attributable and hence deemed to be income of the resident taxpayer, but retains its characteristic nature of dividends, capital gains or interest.
Under the s 31 option, the resident lender will be subject to tax on the actual interest charged. If this is less than the official rate, a tax benefit arises, and is deemed to be taxable. First, taxable income is adjusted and interest is deemed to accrue, and, secondly, donations tax is levied on the adjusted amount.
Interaction with s 7C
The recently enacted s 7C of the Income Tax Act—which deems an interest-free or low-interest loan to a resident trust to be a donation of the interest component, to the extent that the rate applying is less than the official rate, effective as from 1 March 2017 (162 TSH 2016, 167 TSH 2017)—has fuelled speculation about the tax treatment of such soft loans by residents to nonresident trusts.
The Explanatory Memorandum on the Taxation Laws Amendment Bill, 2016 stated that s 7C does not apply to nonresident trusts subject to the transfer-pricing rules of June 2019.
Feature Supplement to 195 s31
In any event, the matter is in my view now settled statutory law vis-à-vis the interaction with s 31, inasmuch as, under s 7C(5)(e) an exemption is granted from the application of s 7C if the loan constitutes an affected transaction as provided for in s 31(1).
Anomaly
Section 7C makes no explicit reference to s 7(8) and para 72. The implication is that both s 7C and s 7(8) and para 72 could apply simultaneously. This is, in my view, unfair, inasmuch as the s 31 route (interest charged or deemed) is exempted and thus preferred by legislation to the s 7(8) and para 72 attribution route.
The legislator should address this anomaly.
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