The 2020 budget speech included a proposal to address a perceived abuse of preference share funding structures for trusts by adding anti-avoidance rules to address the use of such preference share structures for purposes of circumventing the provisions of section 7C of the Income Tax Act.
These anti-avoidance measures were proposed in the 2020 Draft Taxation Laws Amendment Bill that was circulated 31 July 2020.
Section 7C was introduced in 2016 as a mechanism aimed at curbing the transfer of wealth by an individual to connected-person trusts by way of low-interest and interest-free loans, credit or advances, and may extend to connected-person companies included in the trust structure, providing an estate planning benefit primarily driven to manage the donations tax and estate tax liability for the individual. The anti-avoidance measure creates an annual donations tax liability to be triggered in the hands of the natural person initiating the low-interest or interest-free loan, credit or advance. The rules provide that there must be a connected-person link between the individual, the trust and company (where applicable).
Some taxpayers have continued to seek ways around the anti-avoidance mechanism, one such instance being when a natural person subscribes for preference shares with no, or a low rate, of return in a company when more than 20% equity or voting rights in such company are owned by a trust that is a connected person to the natural person. This is because preference share funding fell out of the scope of section 7C because it does not amount to a “loan, advance or credit.”
In terms of the proposed legislation, preference share funding would be brought into the scope of section 7C. Specifically when a natural person or a company (a connected person) subscribes for preference shares in a company when at least 20% of the equity or voting rights are held by a trust that is a connected person in relation to the natural person or the company subscribing to the preference shares.
The deemed donation mechanism would apply when the preference dividends (deemed to be interest for purpose of the anti-avoidance mechanism) equates to an interest rate that is below the official rate of interest. In this instance, the deemed donation liability would be triggered on the difference between the official rate of interest and the preference dividend rate.
The proposal is subject to the public comment process. It is possible there could be some refinement required to the proposed changes to section 7C. It is currently proposed to be effective from 1 January 2021.
Read an August 2020 report [PDF 163 KB] prepared by the KPMG member firm in South Africa
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.