Interest on loans to a trust
You’ve lent money to your trust’s company, perhaps for a deposit on a property purchase or perhaps from selling your property to the trust when it didn’t have the money to pay you.
Either way s7C of the Income Tax Act kicks in.
In simple terms, it says that you must charge interest at least at the official rate (which is the repo rate plus 1%).
If you don’t, then the shortfall that you didn’t charge is deemed to be a donation and that is subject to Donations Tax at 20%.
Now it gets interesting.
If you don’t earn any other interest, then the first R23 800 interest is free of tax (R34 500 if you are 65 or older). That’s R47 600 (or R69 000) if you and your spouse each lent to the company.
So you get up to R69 000 tax free income and the company deducts the expense from its taxable income and saves 27% tax = R18 630.
That’s two big wins.
But let’s say that between you, you lent the company up to R4,7m. The interest on that is (currently) R369K.
You only charge the R69K interest leaving a shortfall of R300K. That’s deemed to be a donation.
But you are each allowed to donate a total of R150K per tax year free of Donations Tax. So, that takes care of the R300K.
Once you go over that, the tax cost of the interest depends upon your marginal tax rate. If you are on the maximum of 45%, then the tax cost is your 45% minus the 27% that the company saves. That is 18%.
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While deemed interest exceeds the taxable interest and donations exemption, you are unable to use the donation to reduce the capital value of the loan (as described in your other article).
Where a married couple have different marginal tax rates, the spouse with the lower marginal tax rate should make the larger portion of the loan as the tax on the deemed interest will be at a lower rate.
Yes Dave,
All of these points are covered somewhere in my articles or books, but I don’t like to write long theses, because they won’t get read.
Except that the annual donations tax exemption has already been used to decrease the original loan amount to the trust to buy the property. You will remain in the S7C loop permanently.
Yes Regine,
Sometimes it’s a good thing, sometimes it’s a bad thing and sometimes it’s just a nuisance. But I don’t write the rules. I just deal with them in the best way that I can.