Setting up a special trust during your lifetime or on your death for a mentally disabled or incapacitated person (including a minor), allows for the safe custody of assets, while at the same time benefiting from lenient tax treatment from an income tax and capital gains tax (CGT) perspective. Unlike conventional trusts, which are taxed at a flat rate, special trusts are taxed on the sliding scale applicable to natural persons.
Sars recognises the following types of special trusts for tax purposes:
Special trust type A
This is a trust created solely for the benefit of a person(s) with a mental or physical “disability”, as defined in Section 6B(1) of the Income Tax Act, where the disability makes it impossible for the person(s) from earning enough money to care for themselves or to manage their financial affairs. This requirement has to be met before the trust will qualify as a special trust type A. Should there be more than one qualifying beneficiary of this trust, the beneficiaries should be related to each other.
These trusts can be either testamentary (a trust created upon your death in terms of your will) or inter-vivos trusts (a trust created during your lifetime), and are sometimes created as a result of a court order in favour of a specified natural person with a disability to assist in the management of his/her affairs. This type of trust will cease to be a type A trust as from the beginning of the year of assessment in which the last beneficiary dies. These trusts are taxed on normal person tax scales.
Special Trust Type B
This is a trust set up in terms of a person’s will, specifically for the benefit of minors who are relatives of the person who died, who are alive on the date of death of the deceased person (including those conceived but not yet born), and the youngest of the beneficiaries is younger than 18 years on the last day of the year of assessment. This means that this type of trust cannot be set up during your lifetime, as you can take care of the minor children yourself. This type of trust will cease to be a special trust type B as from the beginning of the year of assessment in which the youngest of its beneficiaries turns 18. Although these trusts are taxed on normal individual person income tax scales, they offer no benefits as far as CGT is concerned.
What is the tax treatment of special trusts?
Special trusts are treated in a similar way to natural persons for tax purposes, and have the following additional tax advantages:
* The sliding scale for normal income tax purposes as for natural persons ranging from 18% to 45% is applicable, and not the fixed rate of 45%, as applicable to other trusts.
* The annual exclusion for CGT purposes (R40000 a year) is available to special trusts type A, but not to special trusts type B.
* The primary residence exclusion (R2million of the capital gain on disposal) for CGT purposes is available to special trusts type A, but not to special trusts type B.
* On disposal of personal-use assets by special trusts, capital gains or losses thereon may be disregarded for special trusts type A, but not for special trusts type B
* A special trust type A may disregard capital gains or losses on compensation for personal injury, illness or defamation of the beneficiary of that trust, but not a special trust type B
Historically, people moved their assets into trusts to cap the growth on such assets in their estates, and to rather capture the growth in the trusts (which is not taken into account in calculating death taxes and costs).
Assets were sold on loan account to the trusts (as trusts normally do not have money to pay for such assets) and no interest was charged on these loans. Sars recently introduced a tax on interest-free/soft loans to trusts (Section 7C of the Income Tax Act), in order to access the growth on assets in trusts.
As Sars recognised that trusts are also used for purposes other than wealth transfer, they specifically excluded special trusts from the application of Section 7C.
Trusts can be fairly complicated, so it is best to seek advice to ensure that the right structure is put in place to meet your needs. Especially due to the fact that you may no longer be around, you should ensure that your intention and wishes are documented properly to avoid any abuse.
Phia van der Spuy is a registered fiduciary practitioner of South Africa and the founder of Trusteeze, which specialises in trust administration