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[FAQ] A loan by a natural person, or a connected person in relation to a natural person, to a trust

Background

Trust A is a 100% shareholder of Company B. Trust C has a debit loan with Company B (no interest is charged on the loan). Trust C and Trust A have the same beneficiaries and trustees.

Question

1. Is Trust A and Trust C connected parties because of similar trustees and beneficiaries?

2. If Trust A and Trust C are connected parties to each other, will Trust C's loan be subject to a deemed dividend as Trust C is a connected party to Trust A, which holds more than 20% of the shares in Company B?

Relevant tax law

We begin with the definition of “connected person” in section 1(1) of the Income Tax Act.

 “’connected person means-

 (a) in relation to a natural person-

 (i) any relative; and

 (ii) any trust…of which such natural person or such relative is a beneficiary;

 (b) in relation to a trust…-

(i) any beneficiary of such trust; or

(ii) any connected person in relation to such beneficiary;

 (d) in relation to a company-

 (iv) any person, other than a company…that individually or jointly with any connected person in relation to that person, holds, directly or indirectly, at least 20% of (aa) the equity shares or (bb) the voting rights in that company”;

 (e) in relation to any person who is a connected person in relation to any other person in terms of the foregoing provisions of this definition, such other person”.

Note that trustees are not connected persons in relation to a company.

From the above components of the definition: Trust A is a connected person in relation to Company B on account of its shareholding; the beneficiaries of Trust A are connected persons in relation to Trust A; the beneficiaries of Trust C are connected persons in relation to Trust C; the beneficiaries of Trust A (being also the beneficiaries of Trust C) are connected persons in relation to Company B; with the result that Trust C is a connected person in relation to company B.

Now we move to section 7C of the Act: A loan by a natural person, or a connected person in relation to a natural person, to a trust. Company B is connected to Trust A, which through the common beneficiaries is connected to Trust C, whose beneficiaries, being natural persons, are connected persons in relation to Company B. So, the flow of the loan is from the beneficiaries through Trust C to Company B.

Therefore, section 7C of the Act applies to the loan. The interest not charged on the loan (i.e. the amount of interest below interest at the official rate would be treated as a donation on the last day of the tax year and subject to donations tax by the lender."

Webinar Commentary

Further webinar commentary on the tax implications of loans to trusts can also be accessed here.

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