Section 7C Loans To Trusts

Section 7C Loans To Trusts

• 02 May 2024
• Accounting
• The Tax Faculty Tax Specialist

These articles are based on tax law for the year ending 28 February 2025.

1. Background Information

Trust XYZ purchased a primary residence from Trustee A on a loan. Trustee B, who is married to Trustee A, also sold his residential property to Trust XYZ, and the trust owes him the purchase price of the property. No rental income is received by the trust for any of the properties. Trustee A and B use the property sold by Trustee A to the trust as their primary residence and live from time to time in the property sold by Trustee B to the trust. It is assumed that no interest is charged on the loans between Trust XYZ and Trustee A and Trustee B respectively.

2. The Problem / Facts

• Is section 7C applicable to the loan between Trust XYZ and Trustee A?
• Is section 7C applicable to the loan between Trust XYZ and Trustee B?

3. Applicable Law 

Income Tax Act No. 58 of 1962, section 7C

4. Application of the Law to the Facts

Section 7C is an anti-avoidance provision designed to address a situation where a loan is made to a qualifying borrower interest-free or at a rate lower than the official rate of interest as defined in paragraph 1 of the Seventh Schedule to the Act (Official Interest Rate). An amount, calculated as the difference between the interest charged on the loan (if any) and the interest that would have been incurred had the official rate of interest been charged on the loan, will be treated as a donation. This donation is deemed to be made to the trust by that natural person on the last day of his/her year of assessment.

The exception arises if the trust used the proceeds from the loan to acquire a primary residence used by the lender or his spouse.

Based on the information provided, it seems that the loan from Trustee A to Trust XYZ for purchasing a primary residential property used by Trustee A, falls within the exception. Therefore, section 7C does not apply to this loan.

However, the loan from Trustee B to Trust XYZ for the purchase of Trustee B’s residential property does not  qualify for the exception, as Trustee B does not use the property as a primary residence. Trustee A and Trustee B are married (generally married persons live together in a property). Therefore Trustee A and Trustee B use the property purchased by the trust from Trustee A as their primary residence. As a result, it is clear that the property purchased by the trust from Trustee B is not used as a primary residence by Trustee A or Trustee B. Therefore, section 7C is applicable to the loan between Trust XYZ and Trustee B. Trustee B may have to pay donations tax on the deemed donation arising from the low-interest or interest-free loan.

FAQs

1. What is Section 7C of the Income Tax Act in South Africa?

Section 7C is an anti-avoidance tax provision that targets interest-free or low-interest loans made to trusts by connected persons. The law deems forgone interest as a donation, which is then subject to donations tax at 20%.

2. Why was Section 7C introduced?

Section 7C was introduced to prevent tax avoidance through the use of trusts. Before its introduction, individuals could shift wealth into trusts using interest-free loans, avoiding estate duty and donations tax. Section 7C closes this loophole by taxing the imputed interest as a deemed donation.

3. Who does Section 7C apply to?

Section 7C applies to natural persons and connected companies that make loans, advances, or credit to connected trusts. A connected trust is typically one where the lender or a related party is a beneficiary or founder.

4. How is the donations tax calculated under Section 7C?

If the interest charged on a loan to a trust is less than the official SARS rate (currently 9.75% per annum as of 2024), the difference is treated as a deemed donation. Donations tax is then charged at 20% on the first R30 million, and 25% thereafter.

5. What is the official SARS interest rate for Section 7C calculations?

The official rate used for Section 7C is based on the repo rate plus 1%. As of 2024, this rate is 9.75%. If the interest charged on a loan to a trust is below this rate, the shortfall is subject to donations tax.

6. Are there any exemptions to Section 7C?

Yes, exemptions include:

• Loans used to buy primary residences for beneficiaries

• Loans made to public benefit organisations (PBOs)

• Loans where donations tax is already triggered through other provisions

These loans are not subject to Section 7C.

7. Can I avoid the donations tax under Section 7C by charging interest?

Yes. If you charge interest at or above the SARS official rate, no deemed donation occurs, and therefore no donations tax applies under Section 7C. Charging a market-related rate protects the lender from triggering the provision.

8. How does Section 7C impact estate planning in South Africa?

Section 7C affects estate planning by removing the tax benefit of interest-free loans to trusts. Individuals now need to reassess their trust structures, potentially repay loans, restructure them, or charge interest to avoid annual donations tax exposure.

9. Does Section 7C apply to existing loans before the law was passed?

Yes. Section 7C applies to all outstanding loans, including those made before its introduction on 1 March 2017. Ongoing interest-free balances are subject to donations tax annually unless structured to fall under an exemption.

10. What are the penalties for non-compliance with Section 7C?

Failing to declare and pay donations tax under Section 7C can result in penalties, interest, and audits by SARS. It’s important to keep accurate loan agreements and ensure correct interest calculations to remain compliant.

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