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CAPE TOWN – In this advice column Magdeleen Cornelissen from PSG Wealth answers a question from a reader who wants to lend money to his son.
Q: My son is planning to buy a house. I am prepared to lend him R1.6 million interest free, the difference between his available cash and the price so that he does not get stuck with a big bond.
I am retired and have no problem lending him this amount as I am not dependent on its income and he can repay me as and when he can, but what are the tax implications? Do we need a legal document? How do I explain my drop in income to Sars.
The planned transaction between you and your son can be described as an interest free loan. A loan can be defined as money lent on condition that it is repaid, either in instalments or all at once, on agreed dates and usually that the borrower pays the lender an agreed rate of interest. In the case of an interest free loan, however, there are no interest payments.
It is important to take note that one should never lend money to anyone if there is a risk that your own financial health could be jeopardised. This is especially true for retired individuals.
From the details provided, it is clear that you have considered the impact of the planned transaction and the impact it could have on your retirement income. However, you must be sure that you have thought of this over the long term, given how many years it may take for you to be repaid.
Even though you are dealing with family, setting up an official loan agreement or contract in which the outstanding debt is formally recognised is a crucial part of the success of the arrangement. Everyone must know their obligations and agree to them formally. This can be done with the assistance of an attorney, and it should take into account what happens if either party passes away or in the case of non-payment.
This contract will also ensure that the transaction is not misinterpreted as a donation, which would attract donation tax at a rate of 20%. The loan agreement will assist you in explaining the sudden drop in investment capital if such a question did arise from the South African Revenue Service.
You must also remember that the outstanding loan will remain an asset in your hands, even if you should pass away. At that stage such the loan will generally be recognised as an asset in the estate and could therefore attract estate duty. The current estate duty rate is set at 20%, of the dutiable amount.
It would be beneficial to obtain the assistance of a financial planner in setting up this transaction to ensure that the necessary estate planning is completed. The effect of capital gains tax may also need to be taken into account, as you might have to sell an investment to provide the needed loan capital.
Magdeleen Cornelissen is a financial adviser at PSG Wealth in Pretoria.
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