Trusts are used in estate planning for many reasons, but their use in “pegging” an estate with the intention of limiting, or even avoiding, estate duty on death, is often the motivating factor. Estate duty “pegging” (or “freezing“) works like this: assets such as shares, unit trusts or a fixed property are transferred from the planner to the new trust. This is done in order to keep future growth on these as-sets out of the founder’s estate. Estate duty, levied at 20% on the value of an estate over R3.5m (subject to certain rollovers), when the founder dies, is not levied on the assets in the trust.

In implementing the “pegging” strategy, the founder usually avoids simply donating the assets to the trust, as this would attract donations tax on the value of the donation (also at 20%, the first R100 000 donated each year being exempt). The founder thus usually sells his or her assets to the trust, but as the newly created trust has no funds, the

arrangement is that the unpaid sale price will be “on loan account” i.e. no fixed terms for the repayment are stipulated. And the loan by the founder usually remains interest free, due to there being no adverse tax implications in doing so.

In mid–2016 SARS announced certain pro-posed changes to the way these interest free (or low interest) loans to trusts would be treat-ed. In terms of the initial proposals, in cases where no interest (or interest lower than the SARS official rate of 8% p.a.) was charged, the founder/lender would now be “deemed” to have earned interest on the loan at 8% p.a. (or the difference be-tween any lower rate charged and 8%). The taxpayer’s tax free allowance on annual interest earnings could not be applied to this deemed interest. This change could potentially have led to dramatic tax consequences for the founder of a trust: for every R1m of interest free loan account made to his or her trust, the founder would have

R80 000 added to his taxable income (for an amount he hadn’t in reality earned or received). Thus on an interest free loan of R2m, the founder would be deemed to have earned R160 000 in “interest”: the founder’s extra tax obligation due to mak-ing a R2m loan could have been anything up to R65 600 per year (R160 000 x maxi-mum 41% marginal tax rate). Such a re-gime could have led to many founders seeking to wind up their trusts, especially where the trust’s only asset was an illiquid one, such as the founder’s home.

Fortunately, in the revised draft legislation announced towards the end of 2016, a less draconian tax treatment is now pro-posed. Essentially, the failure to charge interest (or the charging of it at a rate lower than 8% p.a.) will to that extent now be deemed to be a donation by the found-er to the trust, and as such will attract the 20% donations tax. The R100 000 annual tax free donation amount will also be al-lowed to reduce the donations tax liability. Thus on

the same R2m interest free loan described above, donations tax of R12 000 would be payable each year ([R160 000-Essentially, the failure to charge interest (or the charging of it at a rate lower than 8% p.a.) will to that extent now be deemed to be a donation by the found-er to the trust, and as such will attract the 20% donations tax. The R100 000 annual tax free donation amount will also be al-lowed to reduce the donations tax liability. Thus on the same R2m interest free loan described above, donations tax of R12 000 would be payable each year ([R160 000-

R100 000]x20%). Importantly, the new draft legislation excludes its application to loans made for a trust to acquire the founder/lender’s primary residence.
These new tax laws are proposed to come into effect from 1 March 2017, and it makes sense for anyone using a trust in their planning to get the trust’s affairs and financial statements up to date and to seek advice on the implications of the new rules.