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Trusts - An Analysis and Overview |
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- What is a Trust
- As the word "Trust" implies, what occurs is that a person, the settlor or Founder, hands over and transfers the right of ownership to a third party being the Trustees to look after particular assets on terms and conditions set out in the Trust Deed. The assets vest in the Trustees and therefore there is a separation of ownership and control from the Founder's Estate. They do not technically vest in the Trustees but only by a fiction of law. This may be a difficult concept to come to grips with. Trust Assets belong to the Trustees insofar as outside parties are concerned but not for the purposes of their own personal affairs.
- The Trust Assets are administered for the benefit of beneficiaries as specified in a Trust Deed because a Founder cannot at the same time be the sole Trustee and sole beneficiary. He can, however, be the sole beneficiary and one of two or more Trustees because by definition the assets are administered by an entity other than the Founder. The Founder can create for himself a right of veto over any other Trustees decisions, or even a power to appoint Trustees without any negative consequences because he is not thereby controlling the discretion of the Trustees. The effect, as we all know, however, is that the Founder rules the roost during his lifetime and possibly, thereafter to a limited extent!
- A Trust, however, does not have any corporate or legal personality. It is an entity, in effect, like cyberspace. It's there it has financial consequences but you can't see it! The financial consequences are that whatever is earned or received by a Trust retains that specific revenue identity for income tax purposes. This has incredible advantages a few of which I want to discuss.
- Advantages
- Life has two inevitable consequences: tax and death! Individuals struggle to build up assets to support themselves in later years and their descendants but are often unaware or seemingly unconcerned that such assets are subject to a 20% Estate Duty charge on death. The solution to this is to ensure that assets, which have an appreciating value, are placed in a Trust from the outset when first acquired. If the Founder or a relative already owns the asset, the Founder can sell it to the Trust via an interest free loan. This results in a non-growing asset, namely a debt, being left in the hands of the Founder and the appreciating assets, i.e. the assets transferred, accruing to the Trust and its beneficiaries. The debt can be reduced at the rate of R100 000,00 a year by way of donations by the Founder or double that amount if each spouse has loaned a portion of the monies. Of course one has to be careful in regard to the debt being written off because whereas R100 000,00 a year is donations tax free, waiving a debt is a CGT disposition.
- There are various other techniques relating to the use of a Trust to hold assets but the answer is the same each time, it saves your children and future generations real money that would otherwise be paid in taxes. With the value of property in South Africa until recently increasing at the rate of 30% p.a., it will be a simple calculation to determine how quickly the 28% (i.e. Estate Duty and CGT) end tax/duty payable is more than covered by a payment of transfer duty now. An example will suffice. Take, for instance, a holiday home now worth R1 million on which transfer duty of approximately R80 000,00 would be payable if transferred to a Trust. Take it that the owner dies 12 years later when the property is worth R5 million equating to a total CGT and Estate Duty liability of approximately R700 000,00 (and allowing for all deductions). Taking the sum of R80 000,00 and compounding it by say 9% a year for 12 years would result a value of approximately R200 000,00 which less CGT and Estate Duty will equate to approximately R145 000,00 (but not including income tax on the interest!) all in, i.e. a difference in value of money in the hands of your family of R555 000,00 in 12 years time.
- From a CGT point of view the Trust offers what can only be described as superb tax prevention. I shudder when I see articles in newspapers pointing out the dire consequences of Trust taxation rates, i.e. 40%, which would mean an effective Capital Gains Tax rate of 20%. However, a Trust is no more than a conduit because income or capital always retains its identity when distributed to beneficiaries. Thus, under a discretionary Trust if the Trustees decide to distribute monies or assets or a gain made on the sale of an asset to a beneficiary, that income / capital will be taxed in the hands of the beneficiary at that beneficiary's marginal tax rate. That beneficiary will be entitled to deduct any allowances that would otherwise have be allowed, any rebate or whatever including the primary abatement of R17 500,00 per year for CGT. Thus, take a Trust with four minor beneficiaries and distribute a capital gain amongst them and for a start one would deduct R70 000,00 and thereafter CGT would apply at a quarter of their tax rates, i.e. in all probability 4,5%! That is the real practical effect of using a Trust whether in holding or disposing of a capital asset. You can't beat it. The principle involved in Trusts is very simply that provided you distribute any monies obtained by the Trust in the same year that they accrue, the tax consequences relating to such monies will be determined by the tax regime applicable to the beneficiary in question.
- Business / Investment Trusts
- Take a company that buys and sells properties. At the end of the day it will be liable to tax at the rate of 28% and to the extent it distributes profits via dividends to an additional secondary tax of 10%, i.e. a total tax rate of 34.5% before monies are received tax free in the hands of shareholders. Say that business is sold by the company and a capital gain results, the same situation will occur namely that the company will pay Capital Gains Tax at the rate of 14% and when distributing the balance of the capital gain a secondary tax at the rate of 10% totalling an overall tax rate of approx. 22% i.e. 2% more than the worst case scenario for a Trust. But now operate the business in the hands of a Trust and what happens to your income. If it is distributed in the same year it accrues, it is taxed at the marginal rate of the beneficiaries. If the beneficiaries are other family Trusts with in turn individual beneficiaries, the same situation occurs. There is an endless variety of how to distribute the monies because the character of the monies is never lost in the wash but retained on distribution to the end tax payer.
- If an investor Trust founder lends a monthly amount to an Investment Trust for the purposes of the purchase of unit trusts or shares in say Satrix 40, on death of the Investor, Estate Duty will be payable only on the outstanding debt but the value of the share portfolio will be exempt from any form of taxation. On the other hand if it happens that the share portfolio has due to market conditions actually dropped in value, the Executor would be entitled to write off the difference leaving a capital loss in the hands of the estate with counter-balancing entries in the Trust; i.e. a capital gain relating to the value of the “waiver” and loss of the share value in question. Take a fairly straightforward example where an investor has a share portfolio valued now at R1 million and sells it to a Trust with a base cost of say R650 000,00. The capital gain would be R350 000,00 which less the deduction would result in CGT of R33 250,00. Taking a rate of growth of say 10% compounded over say a 20 year period on the basis that the investor dies at that time, the Trust would be possessed of a share portfolio in the region of R7 million and not be required to pay any CGT whatsoever. Had the shares remained in the investors name Estate Duty and CGT of approximately R2 million would have been payable (excluding what may then be deductible) as against approximately 200 000,00 being the Estate Duty payable on the interest free Loan of R1 million to the Estate 20 years earlier. The loan would probably, however, have been paid off in any event via dividend distributions to the Investor at no cost or tax over the years.
- The use of Testamentary Trusts is also invaluable as a way of creating a take up for the R3.5 million deduction for Estate Duty purposes albeit that in the latest Budget (2009) it is proposed that the deduction be available in the Estate of the survivor to the extent not utilized in the Estate of the last dying. Often you will see a will leaving everything to "the survivor of us". All very well but it results (presently) in an additional R700 000,00 being paid to SARS by the Estate of the last dying because the R3.5 million abatement has been lost, or not utilised, in the Estate of the first dying. The Testator may not wish to leave that kind of money to his children on death and therefore leaves it to a Trust set up for the maintenance and support of the survivor and the children which in turn terminates on the death of the survivor. Alternatively, the trust can continue forever and a day as a separate form of estate planning for the children and further descendants!
- Special Trusts
- A Special Trust is a concept introduced by the Income Tax Act. There are two types of Special Trusts namely, one for those suffering from a mental illness as defined in the Mental Healthcare Act or a person suffering from any serious physical disability which incapacitates that person from earning sufficient income for his maintenance. The other type of a Special Trust is created in terms of a Will where the Beneficiary (who must be a relative of the Deceased within a third degree of consanguinity) in question is still under 21 years of age. The benefits a Special Trust obtains tax wise cease on the death of the Beneficiary in question or when the youngest attains the age of 21 years. The major advantage of a Special Trust is that it is taxed at the marginal tax rates of natural persons. However it does not obtain the primary or over 65 rebates nor indeed the basic dividend on interest exemption. For CGT purposes the annual exclusion i.e. R15 000-00 applies only to a Special Trust for incapacitated Beneficiaries.
- SARS has confirmed that even though a Special Trust is required to be solely for the benefit of the handicapped Beneficiary other Beneficiaries can be specified in the Trust provided they are not entitled to any benefit until the death of the incapacitated Beneficiary (or alternatively) the youngest Beneficiary reaching the age of 21. This form of a Trust can be used so as to ensure that on the death of the incapacitated Beneficiary, other children or Descendants of the Founder can immediately thereafter benefit as if it were a normal Trust with the advantages previously referred to. This in effect means a double benefit in that not only can incapacitated children be provided for during their lifetimes, but from an Estate Planning point of view one's children and Descendants can be left with an effective Estate Plan. As Trusts are defined as persons for tax purposes, the normal registration for tax purposes is required and accordingly on formation of a Special Trust or indeed any other form of a Trust, the Receiver should be informed and the necessary application for registration effected.
- Setting up a Trust
This can be achieved within a week or two after sending a notarially certified copy of the Trust Deed to the local Master of the High Court with a R100, 00 revenue stamp, who then approves the appointment of Trustees. Who do you appoint as Trustees? Well my advice has always been that one should appoint trusted friends and family members. What are the administration costs involved? Well having appointed Trustees on that basis, very minimal. Of course if professional Trustees are used then an agreed basis of charging will apply. What are the liabilities of a Trustee to the Trust or the beneficiaries? The Trust Property Control Act spells this out by stating that a Trustee must act “with the care, diligence and skill which can reasonably be expected of a person who managers the affairs of another”. I do not think this standard of liability excessive and something which any family member or friend should feel fearful of. There are thus no serious burdens created by acting as a Trustee. While the Act provides that the Master has overall control as to the conduct of Trustees, it is, from a practical point of view, entirely up to the Trustees subject to the provisions of the Trust Deed as to how the affairs of the Trust are managed. An auditor is not necessary, nor required by the Master. Obviously if it is a trading Trust, different circumstances will prevail.
- Conclusion
Thus, the point is that a Trust has simplicity that it ensures that all capital appreciation of assets occurs under its aegis and not in an individual's Estate which is subject to Estate Duty and a capital gain disposition on death. It secures protection from any outside parties including creditors; it ensures that on death any beneficiaries and family members can continue to be provided for without having to await complicated Estate administration winding up processes and can continue for ever and a day. Exactly the same advantage inures for an Offshore Trust but that's another subject.
Andrew Duncan
Estate Fiscal and Tax Specialist.
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