Estate planners must ensure that their advice goes beyond a narrow focus on reducing tax and deliver holistic planning for their clients.
At the annual conference of the Fiduciary Institute of Southern Africa last week, Ronel Williams, a fiduciary specialist at Geneva Management Group, Mauritius, spoke of the myriad complexities introduced to the estate and tax planning disciplines by financial migration in a shrinking world.
“High-net-worth clients can relocate easily - they seldom stay in one place for the duration of their lives - and it is not uncommon for them to reside in one jurisdiction while their assets are invested in another,” said Williams.
One tool available to estate planners to ring-fence their clients’ wealth (and reduce their estate-duty obligations on death) is the trust. A client will typically establish a trust and move (sell or donate) certain growth assets into the trust to insulate the future growth on these assets. “Depending on how the trust is funded, the client may still have value in the estate on death,” said Williams. “But this value will be less than the value of the assets that sit in the trust.”
Individuals can either donate assets to the trust (and incur donations tax) or lend the assets (or sell the assets via a loan account) to the trust. This creates a scenario under which the trust owes money to the individual - meaning that on death the loan account attracts estate duty as an asset in the deceased’s estate.
It was common practice for lenders to trusts to forego interest on these loan accounts to avoid paying income tax. But the National Treasury was unhappy with the practice because it removed both donations tax and income tax from the table. The result was an amendment of the Income Tax Act that requires the lender to a trust to declare any foregone interest as a donation in the year that no interest was charged.
Does this render trusts obsolete?
Williams said that if saving on tax is the sole reason for establishing a trust, it becomes a less attractive option. But best-practice estate planning calls for fiduciary advisers to consider the non-tax benefits of the trust, too. “We still need to consider every possible scenario and reflect on each client in isolation to determine whether the trust makes sense.”
It is taboo for estate planners to start the trust discussion with tax savings in mind - instead, the focus should be on trust benefits, such as the safeguarding of assets and achieving financial security for the trust’s beneficiaries, usually the client’s family.
Estate planners who advise wealthy clients frequently encounter offshore trusts and must deal with the complexity of having trusts and beneficiaries in multiple jurisdictions.
An offshore trust is typically structured to have a 50% or greater beneficial participation in an offshore company. In the past, it was possible for such trusts to distribute capital derived from previous years’ dividends, subject to conditions, to beneficiaries residing in South Africa, without that individual incurring additional tax liabilities.
Recent changes via section 25B of the Income Tax Act mean that capitalised foreign dividends paid to a beneficiary in a subsequent tax year are viewed as income in the beneficiary’s hands and taxed accordingly.
It is important for estate planners and fiduciary advisers to stay up to date with technological developments. Global financial regulators were slow off the mark in deciding whether cryptocurrencies such as Ethereum and Bitcoin should be treated as currencies or assets for tax purposes.
The South African Reserve Bank has since followed the US’s lead in confirming that they regard cryptocurrency as an asset.
“When the owner of cryptocurrency dies there is an asset in the estate that is subject to estate duty,” said Williams. “During life these instruments are subject to normal tax principles - if they are held to generate income, then income tax applies; if they are held to realise growth, capital gains tax is levied.”
She urged estate planners to discuss cryptocurrencies and the tax treatment thereof, both in life and in death, with their clients.
“The world is small and becoming smaller,” Williams said, adding that estate planners had to be flexible to accommodate the estate and tax consequences of clients, beneficiaries and instruments (such as trusts and investments) domiciled in multiple country markets.
Successful estate planning hinges on considering the tax treatment of the beneficial owner and moving away from complex structures. In so doing the estate planner will steer their clients away from unintended tax consequences and greatly reduce compliance costs.