Trust to trust: Things to consider when you sell your assets to a trust
JOHANNESBURG - When assets are sold to the trust, the trust does not usually pay for the assets due to a lack of liquidity in the trust; instead, the trust creates a loan account and owes the seller the money.
Many people are of the view that by selling an asset to a trust, they remove it from their personal estates, but they forget that this loan account will be seen as an asset in the transferor’s personal estate in the event of an insolvency and for Estate Duty purposes.
In the event of an insolvency, all the assets held in trust may be subject to the claims of the estate planner’s creditors, if the loan account is called up and the trust is unable to repay the loan amount (Magnum Financial Holdings (Pty) Ltd (in liquidation) v Summerly case of 1984).
Be mindful that you should draw up a loan agreement when you sell your assets to the trust on loan account. The loan agreement should clearly state all the terms related to the loan, such as the term of the loan, interest rate (for purposes of Section 7C of the Income Tax Act), repayment terms, breach etc.
If there is no loan agreement, it could be alleged that the real intention of the estate planner was to donate the assets to the trust and then Donations Tax will be levied on the market value of the assets “donated” to the trust (in terms of Paragraph 38 of the Eighth Schedule to the Income Tax Act).
Any donation from a natural person more than R100 000 per year is subject to Donations Tax at 20percent of the amount of the donation if the aggregate of that amount and all previous donations during a person’s lifetime is up to R30m and at 25percent of the amount of the donation if the aggregate of that amount and all previous donations during a person’s lifetime is in excess of R 30m. Note that the amount of the Donations Tax payable by the seller may be included in the base cost of the asset when calculating the Capital
Gains Tax payable on the sale (in terms of Paragraph 22 of the Eighth Schedule to the Income Tax Act).
Should the true nature of the transaction be challenged, the Courts have clearly stated that simulated transactions will be ignored. In the Relier (Pty) Ltd v Commissioner for Inland
Revenue case of 1997 the Court distinguished between the substance versus form of an arrangement and held that effect will be given to unexpressed agreements and implied understandings.
In the absence of a written agreement, which contains the repayment terms, the transaction may be regarded as a donation by the South African Revenue Service (Sars). There should also be a real intention to repay the loan. Do also not make the loan repayable on demand, as it may be indicative of control over the trust by the seller.
Another important aspect to remember is to be mindful of the interest rate charged on the loan. Traditionally people charged no interest on the loan (on which Income Tax will be payable by the seller, and which would increase the loan amount that would be included in the estate of such person upon his or her death, which would attract Estate Duty).
Since the introduction of anti-avoidance provisions (Section 7C of the Income Tax Act, which taxes interest-free loans and loans that carrying interest below the official interest rate (repo rate plus one percent)), one has to perform detailed calculations in order to determine which interest rate charged will produce the most favourable tax position, which obviously has to be defendable.
While a trust offers asset protection against creditors, it is important to note that as long as there are loans or claims against the trust by any person (for example the seller), the trust could be exposed to the creditors of that person.
It is, therefore, important to reduce the value of the loan account to zero as soon as is practically possible. Reducing the loan during your lifetime will be largely dependent on the way in which the trust is administered, along with the accounting procedures that are implemented. The smaller the loan remaining in your estate upon your death, the less you will pay in Executor’s Fees and Estate Duty.
Selling your assets to a trust at less than market value in an attempt to minimise the loan amount is not a good idea either, as it will have the following unintended consequences:
You will be liable for Donations Tax on the difference between the market value and the sale price of the assets.
Any income apportioned to this difference will be taxed in your hands until the day you die in terms of the anti-avoidance provisions of Section 7(9) of the Income Tax Act.
If any connected person sells assets to a trust at less than market value, from a tax perspective, the transaction would be deemed to take place at market value and the actual values at which the assets were sold can be substituted by Sars with market values (Paragraph 38 of the Eighth Schedule to the Income Tax Act).
It is clear from the above that a number of issues have to be considered and paperwork completed when you sell your assets to a trust, and if not done properly, it may cost you dearly.
Phia van der Spuy is a registered Fiduciary Practitioner of South Africa®, a Master Tax Practitioner (SA)™, a Trust and Estate Practitioner (TEP) and the founder of Trusteeze®, a professional trust practitioner.