The taxpayer understanding is as follows: 1. Section 7C does not apply to non-resident lenders to SA trusts. 2. Section 7C is also not applicable to cross-border loans, which are not on an arm’s length basis as specified in terms of s31(1) (i.e. if the loan is subject to the transfer pricing provisions) The taxpayer is aware that with effect from 19 July 2017, the scope of Section 7C was widened to include low interest loans to companies where at least 20% of that company's equity shares or voting rights are held by a trust connected to the lender. Does this mean that there are no tax consequences on an interest-free loan from a non-resident where that non-resident lent monies to a company in which a trust (connected to the aforementioned lender) is the only shareholder?
Important:
This answer is based on tax law year ending 28 February 2021.
Answer:
The transfer pricing provisions do not ‘force (the parties) to charged interest’ on the arrangement. It applies where the interest charged is not an arm’s length one. Remember that, for the purposes of section 31 'affected transaction' means any transaction, operation, scheme, agreement or understanding where – (a) that transaction, operation, scheme, agreement or understanding has been directly or indirectly entered into or effected between or for the benefit of either or both- (i) (aa) a person that is a resident; and (bb) any other person that is not a resident; (ii) (aa) a person that is not a resident; and (bb) any other person that is not a resident that has a permanent establishment in the Republic to which the transaction, operation, scheme, agreement or understanding relates; (iii) (aa) a person that is a resident; and (bb) any other person that is a resident that has a permanent establishment outside the Republic to which the transaction, operation, scheme, agreement or understanding relates; or (iv) (aa) a person that is not a resident; and (bb) any other person that is a controlled foreign company in relation to any resident, and those persons are connected persons in relation to one another; and (b) any term or condition of that transaction, operation, scheme, agreement or understanding is different from any term or condition that would have existed had those persons been independent persons dealing at arm's length; … The draft practice prevailing explains this as follows: “Thin capitalisation typically becomes an issue in cases where a South African taxpayer is funded either directly or indirectly by non-resident connected persons.” “In applying the arm’s length basis, SARS requires taxpayers to consider the transaction from both the lender’s perspective and the borrower’s perspective. That is, from the lender’s perspective, whether the amount borrowed could have been borrowed at arm’s length (that is, what a lender would have been prepared to lend and therefore what a borrower could have borrowed) and from the borrower’s perspective, whether the amount would have been borrowed at arm’s length (that is, what a borrower acting in the best interests of its business would have borrowed) … however it is important that taxpayers do not lose sight of the fact that in addition to the amount of debt, the interest rate must also be arm’s length.” Section 7C, see section 7C(1), would apply where the loan was made by a beneficiary of the trust to a company, more than 20% of the shares of which are held by the trust, but you are correct that section 7C, see section 7C(5)(e), does not apply if that loan, advance or credit constitutes an affected transaction as defined in section 31(1) that is subject to the provisions of that section. We don’t understand the following: “Had there been interest charged, would an IT3B have to be made out in a trust or would it be exempt”. We don’t know, based on the facts, if the company is also not resident in the RSA. Section 31 will apply, if the affected transaction results or will result in any tax benefit being derived by a person that is a party to that transaction, operation, scheme, agreement or understanding – see section 31(2). The non-resident has the benefit of not being subject to the withholding tax on interest, if the RSA had a right to tax it under the relevant treaty. But, the withholding tax would only apply if the company is not resident in the RSA.