JOHANNESBURG - Historically, estate planners were advised to move all paid up personal assets into their family trusts. With the punitive measures from the South African Revenue Service (Sars) to attack estate freezing, through the taxation of interest-free or low-interest loans to trusts, introduced in March 2017 (Section 7C of the Income Tax Act), estate planners will have to be careful about which assets they want to protect in a trust and, apart from the sentimental assets, rather focus on moving high growth assets into a trust.
Section 7C was introduced in an attempt to limit the estate duty saving that arises on an interest-free or low-interest loan to a trust that is connected to the lender. It is not always simply about the tax savings, or the additional taxes payable on assets transferred into a trust; it is also about a strategy to protect your assets, and to create continuity and liquidity on your death.
There are also other considerations, such as a contingency plan in the event that you develop Alzheimer’s Disease.
With many people setting up trusts as part of their estate plans, to either protect their assets during their lifetimes, or to ensure continued use of the assets upon their deaths, the founders, beneficiaries and/or trustees may end up using the trust assets, such as living in family homes being transferred into trusts.
As was decided in the FNB v Britz case of 2011, discussed in the previous column, if a trust arrangement is not used for proper commercial or estate planning purposes, a court will not hesitate to declare that the assets do not belong to the trust, but to the individual, who used the trust as a façade. In this instance, the whole objective of setting up the trust will be defeated. This may mean that creditors could access these assets, or Sars could include trust assets in the estate of a deceased, which will attract estate duty.
After the introduction of Section 7C in 2017, using the facts of the FNB v Britz case, at least these punitive provisions would not apply to the loan advanced for the funding of the primary residence transferred from the Britz couple to the trust, as long as the lender or the lender’s spouse used the primary residence throughout the period during the year of assessment that the trust held the residence; this being a specific exclusion. However, if anybody else used the residence, even for a short period of time, this exclusion will not be available, and any interest-free or low-interest loan will be taxed.
Any loans not funding the primary residence would however be subject to Section 7C.
In the FNB v Britz case, the trustees’ loans in lieu of the value of the household content they transferred to the trust were unsecured, did not bear any interest and no specific terms of repayment had been arranged. These terms are typical for family trusts. As these loans did not carry interest at least at the official rate (currently 7.75% a yeart), Section 7C would be applied against these loans.
With the greater focus of Sars on the wealthy, the latest tax return for trusts contains very specific questions regarding the treatment of trust assets.
With regards to the use of trust owned assets, Sars expects trustees to indicate on the trust tax return whether anybody enjoyed the right of use of assets retained in the trust, as well as details of expenses incurred by the trust in respect of the use of trust assets. This means trustees will have to be careful in their dealings with trust assets.
The first complication arises with a trust having a unique feature, where it can have capital and income beneficiary classes, which may be made up of different people. It is therefore important for the trustees to apportion trust expenses fairly between these classes of beneficiaries, as it may impact the amount available for distribution to each class.
Furthermore, as the trustees can utilise the conduit principle (a principle unique to trusts where trustees can decide to push income or capital gains down to beneficiaries, for them to pay tax thereon at their lower tax rates, instead of the trust) to distribute any income or capital gains, together with related expenditure, to beneficiaries, and for them to pay any taxes thereon, the apportionment of expenditure will have to be defendable by the trustees.
Trusts are sometimes used to carry on business and to hold assets. In this instance, it is important for the trustees to apportion expenses correctly and only to allow the deduction of expenses from income to the extent that it was incurred in the production of such income. If a beneficiary, for example, uses trust property free of charge, the trustees will not be able to allocate any expenses incurred on such property to other income of the trust to reduce taxes payable thereon. In answering the question on the tax return mentioned above, Sars will also be able to establish whether the abovementioned Section 7C exclusion will apply to such use of the trust property.
If somebody is employed as employee of a business carried on in a trust, and such employee is allowed free use of trust assets, it may trigger the inclusion of such free use as a fringe benefit of the employee, which will attract employees’ tax.
Trustees have to make an effort, and apply their minds, in the administration of the trust to ensure that they can defend the use of trust assets and the allocation of expenses incurred by the trust.
Their actions must demonstrate that they treat trust assets separately from their own assets, for the benefit of all beneficiaries, and that sufficient trust records are kept of their decisions and the implementation thereof. Without that, the trust may be open for attack by Sars.
Phia van der Spuy is a registered Fiduciary Practitioner of South Africa and the founder of Trusteeze, which specialises in trust administration.
PERSONAL FINANCE