“I recently established a trust. I want to sell one of my properties to the trust by way of an interest-free loan with the trust owing me the purchase price of the property. However, I was advised that such an interest-free loan may give rise to donations tax. Is this so? Is there any way to avoid this?”
Interest-free loans are widely used in South Africa. If one transfers property to a trust by way of an interest-free loan, the property no longer forms part of one’s estate, resulting in a potential estate duty saving on your part when the value of the property increases, but the loan amount remains fixed. The sale of a property to a trust by way of an interest-free loan is generally preferable to a donation as it avoids the payment of donations tax. However, one should bear in mind that where the purchase price of the property is less than its market value, donations tax of 20% may be payable on the difference between the market value and the purchase price as the transaction could be regarded as a disposition for inadequate consideration as contemplated in the Income Tax Act (“Act”).
Notwithstanding the above, there may be further donations tax consequences in respect of the granting of such an interest-free loan. Section 54 of the Act provides for the payment of donations tax on the value of property disposed of under any donation by any resident, with “donation” being defined as “any gratuitous disposal of property including any gratuitous waiver or renunciation of a right.” The Act also defines “property” as including “any right in or to a property”. This raises the concern that the lender of the interest-free loan – who charges no interest and allows for the interest-free loan to remain outstanding - can be seen to have made a gratuitous waiver or renunciation of a right to interest, which constitutes a donation in terms of the Act.
In unpacking this issue, the following two aspects must be considered:
• Does the loan agreement provide for the payment of interest?
• When is the loan repayable in terms of the loan agreement?
Where the loan agreement provides for the payment of interest, but the lender waives the payment of such interest during his lifetime, a gratuitous waiver of his right to interest arises, which waiver could amount to a donation in terms of the Act with donations tax payable. On the other hand, if the loan agreement does not make any provision for the payment of interest on the loan, no “right” to interest exists and the lender cannot waive any “right” to interest and no donations tax will arise.
But even if it is shown that the lender did not waive any “right” to interest and that no donation has arisen, it could still be argued that the granting of a loan to a trust may be seen as a deemed donation in terms of section 58 of the Act. Section 58 stipulates that if “property has been disposed of for a consideration which … is not adequate consideration for that property shall … be deemed to have been disposed of under a donation.” So where a loan agreement provides for the repayment of the loan at some time in the future, it may be implied that the lender will receive inadequate consideration for the property disposed of due to the effect of the time value of the property. On the other hand, should the repayment of the loan be on demand by the lender, it will be very difficult to calculate the lost value of the property disposed of at any specific time and so reduce concerns of such a loan being seen as a donation.
In your case it should be noted that it is currently not general practice of SARS to levy donations tax on interest-free loans. However, to avoid future disputes regarding your loan it will be wise to obtain the help of a tax specialist and conclude a written loan agreement which clearly addresses the terms of the interest-free loan to your trust.