Two family members are entering an interest free loan agreement. Is there a tax obligation on the lender to charge interest or won't there be any tax implications for not charging interest on the loan?
Important:
This answer is based on tax law year ending 28 February 2017.
Answer:
We accept that, if there is a tax benefit, the parties would be able to rebut the presumption of purpose – see section 80G of the Income Tax Act.
SARS’s view, following the Brummeria case, was that “the judgment may be applied in all cases in which benefits in a form other than money (such as the right to use an interest-free loan) are granted in exchange for goods supplied, services rendered or any other benefit given.” But they confirm, in the practice generally prevailing, that the “Brummeria case is clearly not authority for the general conclusion that the value of the right to use an interest-free loan should in each and every case be included in the borrower’s gross income”. It requires the quid pro quo for it to turn into gross income.
Judge Froneman in CSARS v RM Woulidge said, “as long as the capital remains unpaid the failure to charge interest represents a continuing donation…” The court case dealt with section 7 of the Income Tax Act. We accept that the daughter is not a minor.
The parties, if they don’t view this as a donation (not property or the waiver of a right), will have to prove that it was not a donation as defined in section 55(1) of the Act or, if it was, that section 56(2)(c) applies.
With regard to loans to relatives (including children, not minors) it is generally accepted that the interest free loan doesn’t actually result in a donation for donations tax purposes. The question is whether the interest not charged, constitutes a donation – the ‘failure to’ as the Judged said.
Whilst our courts have held that the non-charging of interest is a continuing donation, SARS has only applied that in the context of section 7 and the attribution rules in the Eighth Schedule – essentially for normal income tax purposes.
Section 7C was specifically introduced to cater for the avoidance of Estate Duty and Donations Tax. It deems a donation to arise when an interest free loan is made to a trust by a person connected to the trust (under certain circumstances). We make the comment about section 7C to illustrate that the Act had to be amended to treat the interest free loan to a trust as a donation.