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 the 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 insolvency, all the assets held in trust may be subject to 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) vs Summerly, 1984).
Bear in mind 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, which taxes low interest loans), repayment terms, breach, and so on.
Failing a loan agreement, it could be alleged that the real intention of the estate planner was to donate the assets to the trust, and 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 over R100000 a year is subject to donations tax at 20% of the amount of the donation if the aggregate of that amount and all previous donations during a person’s lifetime is up to R30million and at 25% 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 R30m (for the 2020 tax year).
Note that the amount of 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).
Ensure that any sale of assets to a trust is done in a proper way. If the true nature of the transaction is challenged, the courts have clearly stated that simulated transactions will be ignored.
In Relier (Pty) Ltd vs Commissioner for Inland Revenue (1997), the court distinguished between the substance and the form of an arrangement and held that effect will be given to unexpressed agreements and implicit understandings.
In the absence of a written agreement which contains the repayment terms, the transaction may be regarded as a donation by Sars. There should also be a real intention to repay the loan - the trustees may consider taking out life cover or a term endowment and the proceeds will be used to repay the loan.
Do 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 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 1%]), you have 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 largely depend on the way in which the trust is administered and income-producing assets in the trust. The smaller the loan remaining in your estate upon your death, the less you will pay in executor’s fees and estate duty. In your will you may bequeath any outstanding loans to the trust.
Selling your assets to a trust at less than market value in an attempt to minimise the loan amount is not a good idea, 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 asset.
* 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).
Ensure you consult a professional before moving assets into a trust, as it may cost you dearly.
Phia van der Spuy is a registered Fiduciary Practitioner of South Africa, a Master Tax Practitioner, a Trust and Estate Practitioner, and the founder of Trusteeze.