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In the book, Broomberg on Tax Strategy, it states: "The common assumption is that trusts are some kind of tax panacea ... Then, conversely, from a South African Revenue Service (SARS) perspective, trusts are viewed with a degree of suspicion and mistrust. The truth lies somewhere between these positions. Trusts are useful vehicles, but there is little tax magic that arises from the utilisation of a trust."
"I want to leave my children enough money so that they can do anything, but not so much that they do nothing."
Let's start at the beginning with the origin of trusts, which dates back to the 12th century. Crusading English knights often conveyed ownership of their lands to their trusted friends, on the understanding that the ownership would be conveyed back on their return from the crusades. However, their friends often refused to hand over the property when they came back.
Unfortunately for the crusader, English common law did not recognise their claim. As far as the king's courts were concerned, the land belonged to the trustee, who was under no obligation to return it.
The disgruntled crusader would then petition the king, who would refer the matter to his lord chancellor. The lord chancellor would decide the matter based on his conscience. In the end, he considered it "unconscionable" that the legal owner could go back on his word and deny the claims of the crusader.
Over time, in what became known as the lord chancellor's court (the Court of Chancery), the claim of a returning crusader would continually be recognised. The legal owner would hold the land for the benefit of the original owner and would be compelled to convey it back to him when requested.
The crusader was the "beneficiary" and the acquaintance, the "trustee". The term 'use of land' was coined, and in time, developed into what we now know as a 'trust'.
Today, the concept of a trust has not changed much. Assets are given to a trustee, to administer on behalf of, and for the benefit of, the beneficiaries of the trust. Ownership of the assets is relinquished to the trust.
Tax aside, trusts fulfil an important function in society. Trusts are an ideal vehicle for assets to be administered on behalf of individuals who don't have the capacity to do so themselves; for example, minors and those who are mentally and physically handicapped. Age-related issues can also diminish someone's capacity.
Trusts negate the need for such individuals to be placed under curatorship. The trustees of the trust have a fiduciary duty to ensure that the beneficiaries of the trust are properly looked after, even once the founder of the trust is no longer around.
Trusts are flexible in nature. Family members get married, move overseas, get divorced and have kids. Life is constantly in flux and trusts have the flexibility to be amended to suit a family's ever-changing needs. This flexible character also allows a trust to be adapted to the changing global tax, legal and financial landscape.
I once heard a quote: "I want to leave my children enough money so that they can do anything, but not so much that they do nothing."
Trusts are a useful succession planning tool which can protect beneficiaries, even against themselves if necessary. They allow the founder of the trust to build core values and principles into the trust documents. The trustees of the trust must always consider and adhere to these core values and principles when administering and distributing the assets to beneficiaries. These values and principles will continue to live on, even when the founder is no longer here.
Offshore trusts, if structured correctly, can still be extremely efficient from a tax perspective
Trusts allow for assets to be split between family members and are an efficient way to house complex assets. They also offer protection from creditors. Assets that belong to a trust are also not subject to executors' fees, which can amount to up to 3.5% plus VAT on the gross value of your estate.
On the tax front, trusts still have their benefits, even if these benefits have whittled away over the years.
Interest-free loans to trusts were one of the most tax-efficient ways to fund trusts. An interest-free loan would be made to a trust, and the loan proceeds would then be invested in the trust. This had the effect of pegging the value of the founder's estate to the value of the loan. The growth would be in the trust and it would not be subject to estate duties. The result: reduced estate duties on death.
Is the juice worth the squeeze?
The estate duty saving still rings true today, especially for assets which have a high growth potential, such as new start-up businesses that can be established at a low cost, but that have great potential to grow. However, the new section 7C – which now requires all loans to trusts (or their underlying companies) to be interest-bearing at the official rate of interest (and where if no interest is charged, the interest foregone is taxed as a donation) – means that this benefit now comes at a higher tax cost. It is now a number-crunching exercise to determine if the "juice is worth the squeeze".
Assets can be distributed and passed to the next generation without donations tax being paid. In addition, the conduit principle allows income and capital gains generated in a trust to be taxed at an individual’s tax rate, which is generally lower than the rate at which a trust is taxed. There have been murmurings that SARS is looking at abolishing this principle, which would mean all income and capital gains would be taxed in the trust at the trust marginal tax rate.
Offshore trusts, if structured correctly, can still be extremely efficient from a tax perspective, as the actual trust itself would not be subject to tax if the trust is administered in a low or no tax jurisdiction (as is the case with local trusts). However, most services that come with a foreign currency invoice are expensive. An offshore trust is not a cheap vehicle to administer.
Terminating an existing local and offshore trust also carries a tax and administrative cost. When a trust disposes of an asset to a beneficiary, it's considered a disposal for capital gains tax purposes and could trigger a taxable capital gain. Any asset (along with its growth) that is distributed to a beneficiary would now fall into the beneficiary's estate for estate duty purposes.
What to think about before terminating a trust
If you're considering terminating your trust, you should ‘crunch the numbers’ and also think about:
- The jurisdiction of the trust
- The tax and administration costs of terminating the trust
- The tax benefits and estate duty savings the trust provides, versus the new section 7C tax cost it carries
- The commercial and emotional rationale for having a trust, which includes the significant benefits of the preservation of family wealth.
"Should I keep my trust?" may seem like a straightforward question, but it doesn't, unfortunately, have a straightforward answer. The decision and answer depend on the unique circumstance and dynamics of each family.
About the authors
Rene van Zyl
Joint-head, Investec Tax & Fiduciary
Rene completed her law degree at the University of Stellenbosch and is an Admitted Attorney of the High Court of South Africa. After completing her articles in Cape Town, she joined a multinational offshore trust company, gaining extensive experience in global estate planning and structuring for high net worth individuals, while obtaining her H-dip Tax through Thomas Jefferson School of Law in San Diego, California. Rene was responsible for local and offshore products and solutions at FNB Fiduciary before joining Investec Wealth and Investment as a Tax & Fiduciary specialist in July 2017. Rene has been instrumental in building the Tax and Fiduciary offering for Investec during the last two years, and she was the first founding member of the team. She was also the representative for Digital Assets in South Africa for STEP. She was rated in the Chambers HNW 2019 for professional advisors. Every year they carry out thousands of in-depth interviews with clients in order to assess the reputations and expertise of business lawyers worldwide. The qualities they look for (and which determine rankings) include technical legal ability, professional conduct, client service, commercial awareness/astuteness, diligence, commitment, and other qualities most valued by the client.
Joint-head, Investec Tax & Fiduciary
Lizzie is an admitted attorney, currently busy with her Masters in Taxation. She specialises in tax and cross-border planning and structuring. Lizzie has vast experience in the drafting of local and offshore wills, estate and succession planning, trust and company law, local and offshore trust and company administration, exchange control regulations, tax law and opinions, as well as cross-border structuring and planning. Before joining Investec, Lizzie worked as an associate at a global law firm specialising in tax and cross-border planning, and as a Client Relationship Manager in trust and fiduciary services.