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Trusts: The Critical Tax Savings |
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A Trust is a much under-rated tax saving and fiscal protection entity. 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 Estates of 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 Estates; i.e. for Estate Duty, income tax, creditors or the benefit of the Trustees' 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! Proud parents struggle to build up substantial Estates to ensure that their children and grandchildren are financially secure but are often blithely unconcerned that such assets are subject to a 20% Estate Duty charge on death. The solution to this is to ensure that all 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 written off at the rate of R30 000,00 a year by way of donations by the Founder or double that amount if portion of the debt is donated to a spouse.
- 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 huge amounts of money that would otherwise be paid over to the State to no advantage. Of course one has to be careful in regard to the debt being written off because whereas R30 000,00 a year is donations tax free, waiving a debt is a CGT disposition. In the result a swapping of cheques will achieve the desired effect, i.e. the donor hands over a donation of R30 000,00 and the Trust hands over a cheque for R30 000,00 in repayment of part of the loan.
- With the appreciating value of property in South Africa at present at something like 30% p.a., it will be a simple calculation to determine how quickly the 30% end tax/duty payable is more than covered by a payment of transfer duty now. An example will suffice. Take, for instance, a property now worth R1 million on which transfer duty of approximately R100 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 R900 000,00 (and allowing for all deductions). Taking the sum of R100 000,00 and compounding it by say 9% a year for 12 years would result a value of approximately R281 300,00 which less CGT and Estate Duty will equate to approximately R200 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 R700 000,00 in 12 years time.
From a CGT point of view the Trust offers what can only be described as a superb tax avoidance process. 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, as above pointed out a Trust is no more than a conduit because income or capital retains its identity. 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 R10 000,00 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 R40 000,00 and thereafter CGT would apply at a quarter of their tax rates, i.e. in all probability 4½%! 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.
- TYPES OF TRUSTS
- This leads on to the next analysis namely that there are different types of Trusts. You probably all know of a discretionary Trust where Trustees who have absolute discretion whether to distribute income or capital or both to the beneficiaries. This is generally the case of a family Trust. However, there is also a business Trust where often as not a vesting takes place immediately monies or assets come into the hands of the Trustees on behalf of a particular beneficiary. Take the case of a business operated through a Trust rather than an individual or a company. Take a company that buys and sells tools or vegetables or whatever. At the end of the day it will be liable to tax at the rate of 30% and to the extent it distributes profits via dividends to an additional secondary tax of 12%, i.e. a total tax rate of 37% 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 15% and when distributing the balance of the capital gain a secondary tax at the rate of 12% totalling an overall tax rate of 24% i.e. 4% 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, you know the answer. 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 and possibility of how to distribute the monies because the character of the monies is never lost in the wash but retained.
- The use of Testamentary Trusts is also invaluable as a way of creating a take up for the R1.5m deduction for Estate Duty purposes. Often you will see a will leaving everything to "the survivor of us". All very well but it results in an additional R300 000,00 being paid to the RR by the last dying because the R1.5m abatement has been lost in the Estate of the first dying. The testator may not wish to leave that kind of money to his children straight out on death and therefore leaves it to a trust set up for the maintenance of the survivor and the children which in turn terminates on the death of the survivor, or whenever.
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.
- CONCLUSIONS
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.
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