The Minister of Finance has recently published proposed amendments to section 7C of the Income Tax Act 58 of 1962. The proposed amendments to section 7C target not only loan-based solutions, which was the original intention of the provision, but also corporate estates that make use of preference share structures.
The provisions of section 7C of the Income Tax Act were initially introduced in March 2017. The aim of section 7C was, and still is, to curb the advancement of interest-free or low interest loans or credit from a person to their trust, whether directly or indirectly through a company, under threat of donations tax.
Essentially, taxpayers are prohibited from transferring wealth to their trusts and advancing interest-free or low interest loans to their trusts or companies that are controlled by their trusts. This was countered in many ways by taxpayers, with a common method being the use of preference shares whereby the loans were converted from debt into equity.
After catching wind of these type of structuring methods, the Minister of Finance proposed that the subscription price for preference shares be deemed to be a loan advanced by the taxpayer to the affected company. In addition, any dividends in respect of those preference shares are to be deemed to be interest in respect of such a deemed loan. The deeming provision will apply, if the natural, or a company at the instance of a natural person, subscribes for preference shares in a company if at least 20% of the equity shares in that company are held or the voting rights in that company can be exercised by a trust that is connected to the subscriber. Falling within the ambit of the proposed amendments to section 7C would result in donations tax being levied on the difference between the official interest rate and any preferential dividend actually received by the subscriber in a financial year.
The effect of the proposed amendments to section 7C will in its current format go beyond curbing the provision of loans to trusts as initially intended. Ultimately, corporate estates that include trusts in their structures will no longer be able to issue preference shares to persons connected with the trust regardless of the legitimacy of the transaction, without potentially facing some anti-avoidance challenges.
The amendments are still under debate and changes are still expected. But it would be prudent to be vigilant and proactive to the possible impact of the proposed amendments which are proposed to take effect for years of assessment on and after 01 January 2021. The proposed amendments are clearly aimed at closing what the Receiver perceives to be a loophole in section 7C and as such it can be expected that the Receiver will challenge structures that fall foul of the amended section 7C should it be passed.
Should you have a preference share structure, it would be advisable to have such reviewed timeously by your attorney.