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Cheryl Howard. Image by ANDREW HOWARD
Cheryl Howard. Image by ANDREW HOWARD
RANDS AND SENSE:

Many South African families have children studying or living abroad. Some of the families have created discretionary family trusts for estate planning purposes.

Although trusts have come under the scrutiny of the South African tax authorities, they remain a sound wealth planning tool as a means of preserving assets, particularly for children under 21 who might not know how to manage money responsibly.

However, there are a number of challenges for families with children living overseas when those children are beneficiaries of South African trusts.

Many countries take a hostile view of foreign trusts, and many civil law countries do not recognise the concept. Therefore, a beneficiary of a South African trust who is resident in another part of the world can find him- or herself in a tangled web without knowing how they got there.

If you are considering forming a family trust, it is important to check where the beneficiaries are tax resident and take this into consideration when deciding whether to appoint them as beneficiaries.

If you have a trust and a beneficiary intends moving abroad for any significant length of time, you need to find out about that country’s tax treatment of distributions to beneficiaries of a discretionary trust and seek the necessary advice before the beneficiary takes up residence outside South Africa.

If amendments to a trust deed need to be made once a beneficiary has moved, they must be made with extreme caution in order not to trigger any vesting of trust assets in the beneficiary, or change of the domicile of the trust and or potential capital gains in the trust. This is no easy matter and again expert advice should be sought.

Growing alternative to a testamentary trust

A South African discretionary trust is not able to hold offshore assets directly, unless this is via an asset swop. As a consequence, many South Africans hold offshore assets in their personal capacity, such as via offshore wrapper products, and these need to be taken into account for the purposes of their estate planning.

It has been standard practice to provide for minor children in a will by way of a testamentary (will) trust. Yet a testamentary trust, which comes into existence only on death, cannot be a beneficiary of an offshore wrapper - a trust has to be in existence in order to qualify as a beneficiary of an offshore wrapper.

We have noted a trend among our client base for families to set up a dormant offshore trust (also known as an incubator, freezer, bottom-drawer, standby or pilot trust), which is in effect an alternative to a testamentary trust. Doing this allows the South African settlor to bequeath his or her offshore assets to an existing discretionary offshore trust (dormant until the death of the settlor). It is placed in his or her “bottom drawer” until such time as it needs to receive the assets - which is usually on the settlor’s death but it can also be “brought to life” at any time.

Such a trust, because it is in existence, can be named as a beneficiary of an offshore wrapper.

The advantages include:

* You can retain a larger pot for investment growth (the trust as a single entity receives assets instead of them being distributed among heirs).

* The trust is more flexible and fluid than a testamentary trust which is often age- or event-restricted. For example, a testamentary trust could stipulate that, at age 25 or upon a certain event, the trust will wind up, the beneficiary may be paid out the lump sum and will no longer be subject to the decisions of trustees. In contrast, in a dormant offshore trust, the trustees will play an ongoing role and legacy assets (multigenerational assets) can be held in trust.

* It can be amended more easily than an offshore testamentary trust.

* It allows beneficiaries to accept offshore assets directly (but then, of course, they need to obtain tax advice in their country of residence).

With increasing global mobility and opportunities for children to study and work abroad, you should ensure sufficient flexibility when creating offshore structures and careful consideration should be given to the various merits of setting up a testamentary trust compared to a bottom drawer trust or an active inter vivos trust.

Cheryl Howard is the managing director of Maitland Family Office.