Tax implications of interest-free loans and waiver of debt Professor Jackie Arendse University of the Witwatersrand 15 May

INTEREST-FREE LOANS AND STC 2

Deemed dividend – s 64C(2) an amount is deemed to be a dividend declared by a company to a shareholder where (b) the shareholder or any connected person in relation to that shareholder is released or relieved from any obligation measurable in money which is owed to that company by that shareholder or connected person, to the extent that the amount so owed was not already deemed to be a dividend declared by that company in terms s 64C(2)(g) (c) any debt owed by the shareholder or any connected person in relation to that shareholder to any third party is paid or settled by that company (g) any loan or advance is granted and made available to that shareholder or connected person in relation to that shareholder 3

Exemption provisions - s 64C(4) The deemed dividend rule will not apply if – interest has been charged on the loan at a rate at least equal to the ‘official rate of interest’ for fringe benefits tax purposes (s 64C(4)(d)). This rate is currently 6% per annum. – the loan is repaid or otherwise extinguished by the end of the following year of assessment (i.e. the year following the year in which the loan is advanced) (s 64C(4)(f)). 4

EG 1 ABC CC advanced an interest-free loan of R to its member, Joe Bloggs, on 1 May ABC CC’s financial year ends on the last day of February each year. The loan has not yet been repaid. 5

Result: The financial statements of ABC CC for the years of assessment ended 28 February 2011 and 29 February 2012 will reflect a loan to Joe Bloggs of R The loan does not carry any interest, was advanced during the year ended 28 February 2011 and has not been repaid by the end of the following year, i.e. by 29 February The full amount of the loan is therefore a deemed dividend under s 64C(2)(g) and STC is payable on the loan at the rate of 10%. ABC CC therefore has a STC liability of R (R x 10%). 6

Date of the dividend Where the deemed dividend provision applies as a result of an interest-free loan, the dividend is deemed to have been declared by the company on the date that the loan was made available (s 64C(6)). Under the STC rules, the dividend cycle ended on this date and the STC was due and payable by the end of the following month. Interest will be charged by SARS on any STC liability that remains unpaid after the due date for payment. 7

Result: In the above example a dividend of R was deemed to be declared in May 2010 and the STC should therefore have been paid by 30 June Assuming SARS raises an assessment for STC of R in April 2013, interest will also be payable on the R50 000, calculated at the prevailing interest rate (currently 8.5%) from 1 July 2010 until 31 March

Definition of ‘connected person’ – s 1 Any member of a CC is a connected person to that CC. A non-company shareholder of a company other than a CC is a connected person to the company if he owns (either alone or together with any connected person in relation to himself, e.g. any of his relatives) at least 20% of the shares in that company. A company that owns at least 20% of the equity shares in another company is a connected person to that other company if there is no majority shareholder in the company. 9

Application of s 64C(2)(g) MR x CC aCC bCC c 10 R100k loan

INTEREST-FREE LOANS - DIVIDENDS TAX PROVISIONS 11

Subsequent exemptions The s 64C(2) deemed dividend rule does not apply to the extent that the debt has already been taxed as a deemed dividend under the STC provisions (s 64E(4)(e)). There is exempt from dividends tax any dividend other than a dividend in specie to the extent that the dividend was subject to STC 12

Subsequent repayment of the loan No further tax implications The repayment is deemed to be a dividend that accrued to the company on the date the amount is repaid (s 64C(5)) – after 31 March 2012, the last day on which STC credits could be created – repayment does not give rise to a STC credit 13

Deemed dividend in specie - s 64E(4). Where a debtor owes an amount to a company ‘by virtue of a share held in that company’ during a year of assessment AND the following three conditions are present: 1.The debtor is a person other than a company; 2.The debtor is a resident; and 3.The debtor is either a connected person to the company or a connected person to that connected person. the company is deemed to have paid a dividend in specie on the lat day of the year of assessment 14

Amount of the deemed dividend Calculated by applying a notional interest rate to the loan account balance during the year Notional interest rate = the difference between – the official interest rate (currently 6% as explained above) and – actual interest rate charged on the loan. Only value of the interest differential is a deemed dividend, not the capital amount of the loan. Dividends tax is calculated at 15% on the amount of the deemed dividend and must be paid to SARS by the end of the month following the year- end. 15

EG 2 XYZCC advanced an interest-free loan of R to its member, Sally Shabangu, on 1 April The loan balance has remained unchanged. XYZ CC’s financial year ends on the last day of February each year. 16

Result: XYZ CC is deemed to have paid a dividend on 28 February The amount of the dividend is R5 500 (R x 6% x 11/12) Dividends Tax = R850 (R5 500 x 15%) XYZ CC had to pay this amount to SARS by no later than 29 March 2013 (the last business day of the month) to avoid interest being charged 17

LOANS TO TRUSTS 18

Transferring assets to a trust Donation Sale at MV – Interest on loan a/c ? Is there a quid pro quo (Refer Brummeria principles) – Repayment terms Is there an expectation of repayment (refer NWK principles) – Waiver of loan: CGT implications 19

Loan accounts Par 12(5) – applies until end of 28/2/2013 year of assessment Replaced by par 12A – applies from 1 January 2013 and applicable in respect of years of assessment commencing on or after that date 20

Case law on loans and wills under para 12(5) ITC 1793 (67 SATC 256) – "I bequeath my estate as follows…Any amount which may be owing to me by [the trust] under the loan account, to [the trust]." – Held that the bequest of an amount owing by a debtor, also a trust, to that debtor as legatee, ie as a specific bequest, fell foul of para 12(5) of the Eighth Schedule 21

ITC 1835 (71 SATC 105) (2009) It was clear from the wording of the will that the testatrix’s intention was that her loan account to the trust should form part of the residue of the estate, and it was not separately bequeathed to the trust as a legacy. The trust had at all material times been financially able and in a liquid position to repay the loan had the testatrix demanded payment thereof before her death. The will was a joint will of the testatrix and her husband, and the debt had been due by the trust to the testatrix, not her husband. The testators had jointly disposed of the residue of their estates in the joint will, and this showed that they had in mind no specific bequests of any of their individual or separate assets to either the trust or any other person, apart from the household effects etc expressly awarded as a legacy in terms of the will. Had it been the intention of the testatrix to relinquish her claim in favour of the trust, she could easily have expressed such intention in the will. She had not done so, and this was confirmed by the precise wording of the will. 22

ITC 1835 Accordingly, the testatrix’s claim for the amount of her loan account formed part of the residue of the estate, and it had not been her intention to dispose of this claim in favour of the trust for no consideration as contemplated in para 12(5). Did the method employed by the executor in winding up the estate, whereby the relevant claim was not recovered from the trust but merely awarded to it as the sole residuary heir, bring this ‘award’ within the purview of para 12(5) ? The answer to this question lay in the wording of para 12(5) itself. What was contemplated in para 12(5) was an act by the creditor whereby s/he consciously intended to discharge the debt for no consideration. The determining factor was the intention of the creditor to dispose of the debt, not the subsequent manner in which his or her estate was administered. It was clear that the intention of the testatrix had not been to discharge the debt for no consideration. Para 12(5) therefore N/A 23

Recommended wording… I record that the XYZ Trust is indebted to me on loan account in the amount of R…. I hereby direct that on my death my executor must demand repayment of the loan account from the XYZ Trust. I hereby bequeath an amount of money equal to the amount owing to me under the loan account, to the XYZ Trust. I hereby direct that my executor shall be entitled to apply set-off in relation to the amount due under the loan account and the amount under the bequest. 24

the executor must show the loan account as an asset in the liquidation account and show the bequest as an asset in the distribution account no funds would flow as the executor would apply set-off. 25

Paragraph 12A Where a debt has been reduced and – the debt funded the acquisition of a capital asset – the amount of the reduction exceeds any consideration for the reduction Reduction less consideration = ‘reduction amount’ If the capital asset is still held: – Reduce the base cost by the reduction amount – Any excess reduces any assessed capital loss – Any further excess is recouped under s 19 IF the asset is an allowance asset 26

If the capital asset is no longer held: Allowance asset: reduction amount is recouped under s 19 Assets other than allowance assets: assessed capital loss is reduced by the reduction amount – excess: no further tax consequences 27

Para 12A is N/A to any debt owed by a person - that is an heir or legatee of a deceased estate, to the extent that – – the debt is owed to that deceased estate; – the debt is reduced by the deceased estate; and – the amount by which the debt is reduced by the deceased estate forms part of the property of the deceased estate for Estate Duty Act purposes to the extent that the debt is reduced by way of - – donation as defined in s 55 (1); or – any transaction to which s 58 applies 28

Para 12A is N/A to any debt owed by a person - to an employer of that person, to the extent that the debt is reduced in the circumstances contemplated in para 2(h) of the Seventh Schedule; to another person where that person and the other person are companies that form part of the same group of companies as defined in s 41, unless there is a transaction, operation or scheme entered into to avoid any tax that is a company, where - – the debt is reduced in the course, or in anticipation, of liquidation, winding up, deregistration or final termination of that company; and – the creditor is a connected person – Certain conditions apply 29