May 2018

UKnow Editorial – May 2018

Lately it feels like two sentences keep on repeating itself in my conversations with clients and business partners:

  • It is nearly impossible for the ordinary man to take care of his or her own tax affairs; and
  • Compliance and back-office administration have become so onerous that business owners actually don’t get to focus their time on their core business.

Tax has become such a complicated field and the unfortunate consequence of this is the high cost of tax compliance and specialist advice to the taxpayer. Reading our article on Section 7C in this newsletter will give you some idea of the technicalities of tax, the changes in legislation and administrative procedure that we constantly have to update our knowledge on. Too often we have to help out taxpayers who chose to be penny wise pound foolish, which ended up costing them dearly.

Further to this, we all suffer from the burden of the multitude of compliance requirements and back-office administration in order to run a business in South Africa. It is not doing the growth of our economy any favours, but until things change for the better, the only option left to business owners is to manage this aspect in the most effective way. Delegating these responsibilities to a specialist service provider can end up adding more value to your business, and is worth considering.

With this in mind, we have renewed our focus on using IT and cloud technology to its full advantage in order to offer clients solutions that add value to their business. We strive for constant innovation, not only in terms of our services and resource offering, but also in business strategizing with clients for maximum benefits.

Our new P.S. personal story at the end of our newsletters aims to give a personal touch and behind-the-scenes background to our business and the people in it. We hope you enjoy reading it while getting to know the personality of Unik Professional Services. If you want to respond to or comment on any of our news items or other relevant information, please contact us at news@unikone.co.za or 022 – 482 1169, or join the conversation on our social media platforms on Linkedin, Instagram and Facebook.

Warm regards until next month.

Oddette Boshoff

P.(ersonal)S.(tory) I am wearing my mother’s pearls in this newsletter photo. She is one of the strongest, most generous and caring people I know. She has dedicated her life to her children and family, and still supports me on a daily basis so that I can be all I want to be. For me, these pearls are a symbol of her beauty and strength.

I dedicate Bette Midler’s song “Wind Beneath My Wings” to my beautiful, amazing, strong mother Andrea.

To all the mothers out there – happy Mother’s Day!

 

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Section 7C: The phantom menace – or not?

Much has been written about Treasury’s latest attempt to curb the use of trusts as tax avoidance (not evasion!) vehicles, but it seems the jury is not quite out. The main issue that remains undecided is whether interest accumulating on unpaid distributions falls within the ambit of the provision.

When faced with an interpretation conundrum, it is always good to heed the advice of Julie Andrews in The Sound of Music: “Let’s start at the beginning; a very good place to start.”

What section 7C aims to target is the avoidance of wealth taxes (estate duty and donations tax) where interest free loans are made to a trust. The donor’s asset (the capital amount made available to the trust) remains stagnant, while the capital asset acquired by the trust grows in value. Had the donor simply transferred the asset to the trust, he would have been liable for donations tax. In addition, the donor would often waive or reduce the loan capital using his annual R100 000 donations tax exemption. Doing so, he reduces the value of his assets for estate duty purposes. The absence of interest results in an erosion of the income tax base.

The anti-avoidance provision first saw the light in the 2016 Draft Taxation Laws Amendment Bill. In its original form, it was downright scary:

  • The deemed interest in the loan, i.e. the difference between interest calculated at the official rate (Seventh Schedule fringe benefit rate) and the interest actually charged, would be subject to income tax in the hands of the lender.
  • The deemed interest would not qualify for the annual interest exemption, thus the full amount of “interest” would be treated as taxable income.
  • Any waiver or reduction of the loan amount would be subject to donations tax, with the lender being denied the annual donations tax exemption.
  • The lender would not be allowed to claim any deduction, allowance or loss on the waiver or cancellation of the loan.
  • Finally, the amount of income tax payable on the loan would have to be recovered from the trust within three years. If not, it would be treated as a further donation to the trust.

Needless to say, these proposals were not very well received, the main criticism being that Revenue was trying to cover a shortfall in donations tax and estate duty by imposing income tax. Fortunately, in this case, the cries did not fall on deaf ears and the legislators went back to the drawing board.

The following extract from the Final Response Document issued by SARS and National Treasury shows that they made a complete U-turn:
The interest forgone in respect of interest-free or low interest loans will no longer be treated as income but will be treated as an on-going and annual donation made by the lender on the last day of the year of assessment of the lender.

The revised section 7C came into effect on 1 March 2017 and applies to any amount owed by a trust in respect of a loan, advance or credit provided to the trust before, on or after that date. It applies regardless of whether the loan was made by a natural person who is a connected person by that trust, a natural person who is a connected person to that person, or a company in relation to which that person is a connected person. In other words, there is no getting away.

The difference between the “official rate of interest” and the interest charged on the loan constitutes a donation. Initially the official interest rate was linked to the fringe benefit interest rate determined in the Seventh Schedule to the Income Tax Act, currently 7,5% per annum. However, Treasury perhaps felt that they had surrendered too much with the watered-down edition of section 7C, and for years of assessment commencing on or after 1 January 2018 the “official rate of interest” is now linked to repo rate, with 100 basis points added for good measure.

On the upside, the annual donations tax exemption is back in play to give some relief.

Time to tackle the elephant in the room. From the onset one of the main causes of concern was the matter of beneficiaries’ loan accounts, or “unpaid benefits”. These consist of amounts distributed to beneficiaries but not paid to them and are a common feature of many trusts. Once again, the deliberations leading to the final version of the provision are of value:

Comment: The exclusion of vesting trusts from the application of the anti-avoidance measure is welcomed. However, it does not go far enough and should also exclude discretionary trusts where the income of the trust vest in the beneficiary but are not actually paid to the beneficiary.Response: Noted. This issue stems from the interpretation that vested but accrued distribution are regarded as a loan, advance or credit made by the beneficiary to the trust. This is an interpretation issue that has not been tested and consideration will be made on the provision’s practical application in such scenarios.

The Explanatory Memorandum on the Taxation Laws Amendment Bill 17B of 2016 goes a step further:

An amount vested by a trust in a trust beneficiary that is not distributed to that beneficiary will, however, qualify as a loan or credit provided by that beneficiary to that trust if that non-distribution results from an election exercised by that beneficiary or a request by that beneficiary that the amount not be distributed or paid over, e.g. if the beneficiary has reached the age at which a vested amount must be paid over or distributed to him or her and the trustee accedes to a request by that beneficiary that this not be done; or the beneficiary enters into an agreement with the trustee in terms of which the amount may be retained in the trust.

So, it seems that as long as the beneficiary does not explicitly agree to the funds being retained in the trust, the unpaid benefit should not be treated as a loan or credit advanced to the trust. Somehow, this is not comforting enough to put beneficiaries with unpaid benefits at ease. Especially if the rather nasty prototype of the original section 7C is any indication of how seriously SARS wishes to curb the use of trusts to avoid (any) tax. And remember, agreements come in various shapes and forms. It is not inconceivable that, in the scenario sketched in the Memorandum, SARS may view a failure by the beneficiary to request payment of distributed amounts as a tacit or implied agreement that causes the whole arrangement to fall foul of section 7C.

In trying to get to the bottom of this, there have been two guiding lights. The first is the stated purpose of section 7C. The Explanatory Memorandum is quite straightforward; the aim is to “limit taxpayers’ ability to transfer wealth to a trust without being subject to tax”. A beneficiary who does not receive payment in respect of distributions is surely not transferring his wealth to the trust. Or is he?

The second guiding light comes from SAIT’s Piet Nel in the course of a recent tax update webinar, and specifically his focus on a verb. Section 7C applies to a loan, credit or advance provided by a person to the trust. He used the Oxford Living Dictionary to define “provide” as “make available for use”. To provide requires more than mere acquiescence. If the vested funds merely stay in the trust, held in trust for the benefit of the beneficiary, there should be no problem. However, what if the trustees decide to use those funds to acquire a new asset or enhance the value of an existing asset? Then we are back to exactly the kind of mischief the legislation aims to prevent.

And not wanting to be a prophet of doom, there is another tiny word that causes ominous ripples in the back of the mind. Time to call a spade a spade. Many trusts are used as vehicles to deflect income tax and capital gains tax to beneficiaries who are taxed at a lower rate. This is perfectly legal. Section 25B provides that to the extent to which an amount has been derived for the immediate or future benefit of any ascertained beneficiary who has a vested right to that amount during that year, that amount will be deemed to have accrued to that beneficiary. Now, in the context of income tax, “accrued” has been held to mean “unconditionally entitled”, even if payment is to be effected somewhere in the future.

What niggles is this: In order to have a favourable tax treatment of trust receipts and accruals, we need to have a beneficiary with a vested right to the income or capital gain. On the other hand, the beneficiary’s right to his share of that income or capital gain needs to be watered down and be made dependent on an additional decision to actually make the payment, lest it be regarded as the tacit provision of a loan, advance or credit.

Once again, back to the Explanatory Memorandum:

An amount that is vested irrevocably by a trustee in a trust beneficiary and that is used or administered for the benefit of that beneficiary without distributing or paying it to that beneficiary will not qualify as a loan or credit provided by that beneficiary to that trust if

  • the vested amount may in terms of the trust deed governing that trust not be distributed to that beneficiary, e.g. before that beneficiary reaches a specific age; or
  • that trustee has the sole discretion in terms of that trust deed regarding the timing of and the extent of any distribution to that beneficiary of such vested amount.

It is significant that the Memorandum makes reference to that beneficiary and such vested amount. Can it be inferred that that amount may then not be applied for the benefit of any other beneficiary? Prof. Walter Geach’s comments in a seminar hosted by CM2 in August 2017 certainly seem to point in that direction:

“In my opinion, if the amount that has conditionally vested in a particular beneficiary is pooled with all other trust funds and any income and/or capital gain can arise therefrom for the benefit of other beneficiaries, this would amount to a loan, advance or credit as envisaged by section 7C.”

What is required to steer clear of section 7C’s tentacles is essentially a two-tier exercise of discretion by the trustees. First, to vest an amount in a beneficiary and then, later, to pay that amount to the beneficiary. Prof. Geach explains as follows:

“Because a beneficiary cannot claim payment (i.e. cannot enjoy the amount/asset) until the happening of that event, there is no loan, advance or credit made by that beneficiary to the trust. Therefore section 7C cannot apply. This type of vesting is known as ‘conditional vesting’”.

With conditional vesting we can play it safe for purposes of section 7C. The question is: Are we then still toeing the line for purposes of section 25B?

Annalize Duvenage
Specialist Tax Consultant

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Evidence is key – SARS’ Questions (Part 2)

Firstly, a big thank you to every person out there who read the first edition of Evidence is Key in our previous issue of UKnow. It keeps me motivated to keep on writing and I hope to help someone somewhere.

This follow-up article deals with information requested from an individual taxpayer, while my next article will focus on trusts, BUT remember that SARS can ask these questions for any type of taxpayer.

1. Vehicle and Travel Costs
Much has been said about motor vehicles and travel claims, and I hope I am not repeating myself. If so, please consider this a reminder. Below is a typical calculation for motor vehicle expenses incurred by an individual taxpayer.

(Click to enlarge image)

If you look at the above calculation, what supporting documents would be required of the individual taxpayer?

The cost price of the vehicle: SARS wants a signed purchase agreement, as well as an invoice – not a quote. If you only have an unsigned copy of the purchase agreement, you will need to provide 3 months statements showing repayments, or a letter from the financing institution confirming the amounts on the electronic agreement. So to make things easy, please make sure you have a signed copy of the agreement.

I quote the following SARS question received:

Supporting Documentation Required: Kindly provide the following invoices / calculation and supporting documents is requested: Donations and depreciation as well as all documentation regarding business expenses that is taken into account and calculation regarding travelling.

If we look at the above calculation, the taxpayer will need to provide the following:

Bank Charges: This will be indicated on the monthly statements of the financial institution.

Fuel: Please keep you receipts! Some of the receipts do fade over time, so make sure you can still read it. Even better, scan the receipts and keep them as electronic records while they are still new. (Nowadays some fantastic software is available to scan all documentation and keep it for record purposes or serve as the basis for cloud accounting and bookkeeping. Please contact us for more information on this.)

Depreciation: The purchase amount (cost price) will be confirmed on the signed purchase agreement and invoice. If you cannot claim the VAT on the purchase of the vehicle, the VAT forms part of the cost price.

Repairs and Licenses: These will be amounts paid for example the services of the vehicle, replacement of tyres and the vehicle license fee. All original invoices must be kept.

Finance charges: SARS is not always satisfied with an amortisation schedule – they want either a letter from the financial institution confirming the amount of interest incurred, or a tax certificate confirming the interest amount. Make sure you receive this every year, as some financial institutions close the account when the loan amount is repaid and cannot access the information at a later stage.

Insurance: An insurance contract can be a lengthy document, so we usually send SARS only the page of the insurance contract that reflects the amount for the vehicle we claimed. However, SARS may request the entire original contact for verification.

2. Other Regular Deductions

Donations: Please note that only donations for which you have received a valid original section 18A certificate can be claimed as a tax deduction.

Medical Expenses: There is a guide on the SARS website on how to determine the amount of medical expenses that can be claimed as a tax deduction, what to include in this amount and what not. This topic can be a newsletter on its own! The short version is: You will need all invoices and proof of payment of all out-of-pocket expenses not covered by your medical aid fund. Note non-prescription medication is not tax deductible.

As per my first article….remember that the taxpayer bears the onus of proving that an expense was incurred in the production of income. The golden rule is: If you want to claim it, you need to prove it. So make sure that your supporting documents are complete and correct.

Petro van Deventer
Senior Manager

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