johannesburg - The SA Revenue Service (Sars) attempts to limit the abuse of trusts as a means of tax evasion by individuals. Sars identifies persons and entities that are closely connected to the beneficiaries of the trust - especially where income and capital gains have been transferred to such persons and entities - since the beneficiaries are the parties who will directly benefit from all income and capital gains accrued in the trust.
Who are connected persons relative to a trust?
Any beneficiary of a trust.
Any connected person in relation to such beneficiary, in other words:
If the beneficiary is a natural person, then any relative (by blood or marriage) will also be connected to the trust, as well as any trust of which such natural person or such relative is a beneficiary
Persons who are connected persons in relation to a trust are connected persons in relation to each other, thereby widening the net in terms of the definition of the term “connected persons” (this makes the net very wide)
If the trust owns 20percent or more of a company, all the beneficiaries of the trust will be connected to that company
If the beneficiary is a company, then any other company which is held more than 50percent by such beneficiary company
Donation or interest-free/soft loan to the trust to get assets into the trust:
If a connected person, being a South African resident, made a donation or soft/interest-free loan to the trust, or where the founder retains certain rights in the trust deed, all income generated resulting from such a donation or gratuitous disposition will be taxed in the hands of such person until his/her death, instead of the trust itself, or its beneficiaries (Section 7 anti-avoidance provisions for Income Tax).
Similar anti-avoidance provisions for Capital Gains Tax exist in terms of Paragraph 68 to 73 of the Eighth Schedule to the Income Tax Act.
After the donor/funder’s death, the trust will be taxed on the income or capital gains retained in the trust.
These sections are therefore not concerned about who formed or created the trust, but rather with the person who transferred the assets into the trust at favourable terms.
These sections effectively seek to tax the person who introduced the assets into the trust on the income and capital gains generated by those assets.
These provisions override any other provisions aiming to tax trust income or capital gains.
Buying, selling or distributing assets below market value:
When the trust buys an asset at a below-market-value price from connected persons, or if a disposal is made, to a connected person who is not at arm’s length - in other words, not acting as independent, unrelated and well informed party - then the acquisition or disposal will be deemed to have been done at the market value (Paragraph 38 of the Eighth Schedule to the Income Tax Act).
Section 7 of the Income Tax Act will then be applied to the difference between the market value and the actual transaction value, as a donation.
A similar argument holds for distributions of trust assets to beneficiaries (who by definition are connected persons), for example, properties held in the trust.
This is because the vesting (distribution) of an asset in a beneficiary is defined as a disposal (Paragraph 11(1) of the Eighth Schedule to the Income Tax Act), and as such, any asset distributed to a beneficiary will be regarded to have taken place at the market value of such asset, regardless of the value that the trustees placed on such asset.
Capital losses on transactions conducted between connected persons in relation to the trust will be disregarded when calculating the total capital gain/loss in the hands of such connected person, for example, the sale of trust assets to a beneficiary (Paragraph 39 of the Eighth Schedule to the Income Tax Act).
Unutilised losses - also referred to as “clogged losses” - are carried forward, and may be offset against capital gains with the same connected person in the future, should this person still be a connected person at the time.
This ring-fencing takes place per connected person.
Recover taxes paid due to the anti-avoidance provisions of the trust:
Very few people are aware of the following: Any tax payable by the donor or funder “may” be recovered from the person entitled to the receipt (Section 91(4) of the Income Tax Act). In the event that these taxes are not recovered from the trust, it will be regarded as a donation of such amount on which donations tax will be payable.
Donations tax on interest-free/soft loans:
With the recent introduction of tax on interest-free or soft loans to trusts (which previously capped estate duty in the persons’ hands who made such loans), the “connected person” rule reared its head again.
The amended Section 7C targets “affected loans”, which encompass interest-free loans, or loans with interest below market interest rates, that are made, directly or indirectly by:
A natural person or a company that is a connected person in relation to that natural person (where the loan is made at the instance of that natural person) to a trust in relation to which:
(a) That person or company is a connected person.
(b) Any person that is a connected person in relation to the person or company referred to in paragraph (a) above; or to a company that is a connected person in relation to the trust referred to above.
The inclusion of “connected persons” in the wording of Section 7C has a “catch-all” effect.
The wording attempts to close any loopholes that a person may try to utilise, by way of advancing the low interest or interest-free loan through a relative, a company in which they are a shareholder (with an interest of more than 20percent), a beneficiary of another trust to which they are related, and so on.
For example, the provision has been extended to include loans bequeathed to connected persons (such as your child or spouse) (Refer to point (b) above). When the loan is transferred to the legatee/heir, he/she will be deemed to have made the loan on that date.
When setting up a trust, be mindful who you link to the trust, through the structure, or through transactions.
Even though Sars introduced these anti-avoidance provisions, it may result in less taxes payable in the donor/funder’s hands compared to a trust.
So it may even be in your favour, if you apply it correctly. Speak to a trust practitioner to assist you, as it can become rather complicated.
Phia van der Spuy is the founder of Trusteeze
-BUSINESS REPORT