Nozipho Cele, CA(SA)
There is a transaction sitting on the balance sheets of thousands of South African family trusts right now. An interest-free or below-market loan from a founder or shareholder to their trust is quietly generating a donations tax liability every single year. Many of the people who structured those loans in good faith are either unaware of this, or are relying on an adviser who has not revisited the position since 2017.
Section 7C of the Income Tax Act 58 of 1962 came into effect on 1 March 2017. It did not receive the same frenzied attention as, say, the dividends tax amendments or the beneficial ownership register. But for any business owner who has used a trust as an estate planning or asset-holding vehicle and who funded that trust with a loan, Section 7C is arguably the most consequential piece of tax legislation of the last decade. It fundamentally changed the economics of trust lending, and it has no sunset clause.
What Section 7C Actually Does
The mechanism is deceptively simple. Where a natural person (or a company acting at the instance of a connected natural person) extends a loan, advance, or credit to a trust, and the interest charged on that loan falls below the official rate of interest, the shortfall is deemed to be a donation made by the lender to the trust on the last day of the tax year, being 28 February.
That deemed donation is subject to donations tax at 20%, with the first R100,000 of donations in any tax year falling within the annual exemption.
The official rate of interest is defined in paragraph 1 of the Seventh Schedule to the Act. For rand-denominated loans, it is the repo rate plus 100 basis points, updated each time the South African Reserve Bank adjusts the repo rate. This is not a static number. It moves, and the deemed donation moves with it.
The implications are immediate:
- A zero-interest loan does not escape tax. It generates a deemed donation calculated on the full outstanding balance.
- A loan at a rate lower than the official rate generates a deemed donation on the differential, not just for the year of origination, but every year the loan remains outstanding.
- Capital repayments reduce the base on which the deemed donation is calculated. Interest repayments do not.
Who Is Caught
Section 7C is not limited to the founding settlor. The provision applies to any natural person who is a connected person in relation to the trust, as well as to any company that extends a loan at the instance of a natural person who is a connected person to the trust. In the trust context, a connected person includes:
- Any person who is a beneficiary of the trust.
- Any relative of a beneficiary (within the definition of "relative" in the Act, which extends to siblings, parents, grandparents, children, and their spouses).
- Any company controlled by the trust or by a connected person of the trust.
This means the net is wide. A shareholder who lends money to their company, which in turn lends to a trust in which the shareholder's children are beneficiaries, may find the company loan squarely within the ambit of Section 7C.
There are, however, specific exclusions:
- Employer loans for primary residences. Where a loan is extended to a trust and the trust uses the proceeds to acquire a primary residence occupied by the lender or the lender's spouse, the deemed donation provisions do not apply to that portion of the loan.
- Vesting trusts under Section 7C(1A). Certain bewind trusts and vesting trusts with specific characteristics are excluded, but the conditions are technical and must be verified against the actual trust deed.
- Deceased estates. The provision does not apply to a loan by a deceased estate.
These exclusions are narrower than many clients assume. The primary residence exclusion, in particular, applies to the trust's use of the loan, not the lender's intention at the time of making it.
The Calculation: A Worked Example
Consider the following scenario. Sipho Khumalo is the founder of a successful distribution business. In 2018, he established the Khumalo Family Trust (a discretionary inter vivos trust) and extended a R5,000,000 interest-free loan to the trust. The trust used these funds to acquire a residential investment property in Sandton, now let to a commercial tenant. Sipho is a trustee and his three adult children are beneficiaries.
| Component | Amount |
|---|---|
| Outstanding loan balance | R 5,000,000 |
| Official rate of interest (repo 7.50% + 1%) | 8.50% |
| Interest that should have accrued | R 425,000 |
| Actual interest charged | R 0 |
| Deemed donation (Section 7C) | R 425,000 |
| Component | Amount |
|---|---|
| Deemed donation | R 425,000 |
| Less: Annual exemption | (R 100,000) |
| Taxable deemed donation | R 325,000 |
| Donations tax at 20% | R 65,000 |
Sipho owes SARS R65,000 in donations tax for the 2026 tax year, in addition to whatever he owed in prior years. And if the repo rate moves upward, that liability increases. If the loan balance has not been reduced, the base remains R5 million. Across a five-year period, the Khumalo family has accumulated a significant and compounding tax obligation that was never budgeted for and has never appeared on any management account.
This is not a hypothetical. Variations of this scenario exist in virtually every family with a discretionary trust established before 2017.
Section 7C is not a loophole. It is a structural feature of the tax system that penalises inertia.
The Pitfalls Advisers Miss Most Often
1. Assuming the exemption covers it.
R100,000 sounds meaningful until you apply it to a multi-million rand loan at an 8.5% official rate. On any loan exceeding approximately R1.18 million at current rates, the deemed donation will exceed the annual exemption and donations tax will be due.
2. Not tracking the official rate.
The official rate is not fixed at inception of the loan. It resets with every repo rate change. A client who structured a loan when the repo rate was 3.5% (2020 to 2021) is now exposed to a very different rate environment. The deemed donation has grown materially, and retrospective non-compliance is entirely possible if the position was never revisited.
3. Confusing donation of the loan with repayment.
Some clients are advised to donate the loan to the trust to extinguish it. This does not avoid donations tax. It triggers it immediately on the full outstanding balance, at 20%. At R5 million, that is a R980,000 once-off tax liability (net of the R100,000 exemption). The question of whether it is better to donate or to keep servicing the annual deemed donation is a quantitative one that requires proper modelling.
4. Missing the company-at-the-instance-of test.
Where a company (often the operating entity) has extended a loan to the trust at the behest of a connected natural person, the liability for the deemed donation falls on the natural person, not the company. This distinction affects who is responsible for the donations tax return and who bears the cashflow impact.
5. Ignoring the interaction with estate duty.
Section 7C reduces the growth in a person's dutiable estate by taxing the annual economic benefit transferred to the trust. However, the loan itself remains a personal asset in the estate until it is repaid or donated. Estate planners who have not modelled both the Section 7C cost and the residual estate duty exposure are working with an incomplete picture.
What Should Be Done Now
If you have an outstanding loan to a trust and have not formally reviewed your Section 7C position since 2017, the first step is a technical assessment, not a restructure, and certainly not a panicked donation of the loan. That assessment should:
- Quantify the outstanding loan balance and the date of origination.
- Apply the official rate for each relevant tax year to determine the cumulative deemed donation.
- Determine whether the annual exemption was applied in prior years and whether donations tax returns were submitted.
- Model the cost of three scenarios: charging interest at the official rate going forward, making capital repayments to reduce the base, or donating the loan in tranches.
- Consider the interaction with estate duty and any existing will or estate plan.
Where prior-year deemed donations have not been declared and donations tax has not been paid, voluntary disclosure remains an option under the Voluntary Disclosure Programme. SARS has been increasingly active in trust-related audits since 2022, and proactive disclosure is invariably less costly than reactive compliance.
The Broader Point
The trusts that were established with the best intentions in the pre-2017 era are now carrying tax liabilities that grow silently, year after year, at whatever rate the Monetary Policy Committee decides.
The clients who will be most exposed when SARS eventually arrives are not the ones who were trying to evade tax. They are the ones who were never told that the rules had changed.
Make sure you are not one of them.