Remember Section 7?
Section 7 of the Income Tax Act targets assets which are donated by a taxpaying person to another person with the intention of avoiding tax on the profits derived from these assets. Keeping Section 7 in mind is therefore crucial for effective annual tax planning.
This Section applies when the donor is alive at year-end. Any interest-free loans may also be regarded as donations.
The following are examples of specific tax avoidance scenarios that can be targeted by Section 7:
- A taxpayer – and founder of a trust – donates a profit-making investment to his trust and at year-end the trustees of the trust distribute the profits from this investment to his minor child, who is in a lower tax bracket than the parent. In this way the taxpayer avoids being taxed on the profits in his personal capacity. According to Section 7(3), the taxpayer will be taxed in his own hands on these profits, and not the minor child.
- A taxpayer transfers an investment to his spouse, a homemaker, so that she rather than he can be taxed on the profits of this investment. As donations between spouses are exempt from donations tax, he not only saves on donations tax but his wife pays tax at a lower marginal tax rate. Section 7(2) specifically deems these profits to be taxed in the hands of the taxpayer and not in the hands of his wife.
- A taxpayer transfers an investment to his minor child. He pays the donations tax (if the donation exceeds R100 000), but the child is taxed at a lower tax rate. Again, Sec
- A taxpayer transfers an investment to a child or any other person living and working overseas (i.e. a non-resident for tax purposes). He does not pay taxes on his foreign income in South Africa, but only on his South African investments. The recipient will most likely be taxed at a lower marginal tax rate in South Africa. According to Section 7(8), this income will be taxable in the hands of the taxpayer.
- A taxpayer donates a profit-making investment to his trust and at year-end the trustees of the trust distribute the profits from this investment to a beneficiary who works and lives overseas, i.e. a non-resident. Section 7(8) also addresses this scenario: the taxpayer will be taxed in his own hands on these profits; not the non-resident beneficiary.
- A taxpayer donates an investment to his trust and decides not to distribute the profits to the beneficiaries but rather to retain the profits within the trust. Section 7(5) deems these profits to be taxable in the hands of the taxpayer and not the trust.
- A taxpayer who holds and investment but cedes the profits of the investment to someone else, will be taxed on these profits in his own hands according to Section 7(7).
While the examples cited may be the most common ones, there may be other scenarios which require careful consideration. Taxpayers need to ask the following questions with every transaction:
- Am I donating this asset?
- To whom am I donating this asset?
- Who will be taxed on the profits deriving from this asset?
Taxpayers who know the answers to these questions are busy with effective tax planning and will be able to take informed decisions.
For further information, contact David Badenhorst of Tenk Loubser & Associates in Tygervalley, tel. 021 915 6666 or e-mail firstname.lastname@example.org