Use a trust
Any natural person can be a beneficiary of a trust.
If a minor is a beneficiary, he or she must be supported by a guardian when a beneficiary’s decision is required. It therefore makes sense to proactively structure assets in a trust as part of your estate planning, when minors may inherit. You can either set up a testamentary trust (in your will) upon death or an inter vivos trust during your life.
The main difference between a testamentary trust and an inter vivos trust is that if you only create a testamentary trust upon your death, capital gains tax, estate duty and executor’s fees will be payable before the assets are transferred into the trust, whereas assets accumulated in an inter vivos trust will not attract any taxes upon your death.
If you decide on a testamentary trust, your will should spell out who the trustees and the beneficiaries will be, the responsibility of the trustees, and any other conditions. These provisions should be detailed enough to protect your assets for your heirs. Often, wills do not provide sufficient measures to ensure that trusts are executed properly.
This type of trust is 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, and will cease to be a special trust as from the beginning of the year of assessment in which the youngest beneficiary turns 18.
Special trusts are taxed on normal individual-person tax scales for both income and capital gains.
Ring-fence a maintenance obligation
A trust is also a useful tool to utilise in a divorce settlement, whereby a divorce settlement can be transferred into a trust and be applied for the benefit of typically minor children and a spouse.
If a person is obliged in terms of a court order to transfer assets into a trust, it is unlikely that donations tax would be leviable on that transaction, as it is not motivated by pure liberality or generosity - a requirement for the application of donations tax.
In Estate Welch v Commissioner for Sars (2004), more than R3million was transferred to a trust for the maintenance of the ex-wife and their child, for their maintenance in terms of a divorce settlement. The court held that the transfer of assets was not a donation which triggered donations tax. The ex-husband received an undertaking from the trustees to discharge his liability resulting from the court order; therefore the assets were not transferred to the trust for nothing.
The Income Tax Act contains certain anti-avoidance provisions applicable to trusts that aim at taxing any income or capital gain as a result of a donation, a soft loan, or a similar act to specific people, such as a minor child. These provisions effectively seek to tax the donor/funder on the income and/or capital gain generated by those assets, instead of, for example, the minor children.
Income, and similarly capital gains, distributed and applied for the maintenance, education or benefit of beneficiaries, or accumulated for the benefit of beneficiaries, who are minor children or stepchildren (but not grandchildren) of the donor/funder, is deemed to be the income of that donor or funder and will be taxed in his or her hands (section 7(3) of the Income Tax Act and paragraph 69 of the Eighth Schedule to the Income Tax Act).
Be careful of selling assets to a trust at below market value. Should assets be sold to the trust at less than market value, the above provisions will apply to the difference between the market value and the sales price. The donor or funder - instead of the beneficiary - will be taxed on this income or capital gain.
As a tax advantage, trustees can use the conduit principle (a principle used to push the tax liability to beneficiaries, away from a trust) and distribute income to various beneficiaries, who do not earn enough to pay tax. Individuals younger than 65 earning up to R79000 income a year, and individuals 65 years and older earning R122 300 income a year do not pay tax. Trust income can therefore be split among a number of beneficiaries who earn up to this threshold, resulting in them paying no or very little tax on trust income.
By using the trust as a conduit, the trustees can pay the school fees of the grandchildren (but not the children, as this will trigger the anti-avoidance provision discussed above) of the donor or funder (the person who made a donation or soft loan to the trust) and have the income taxed in their hands. Each grandchild will not be liable for tax until his or her income exceeds R79000.
The same is true for the major children of the donor or funder and for the minor children of a deceased donor or funder. For each child receiving R79000 a year, a tax saving of R35550 ( R79 000 x 45%) may be achieved. So if you distribute R79000 to five of these qualifying people, you will save R177750 (R35550 x 5) in tax.
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, a professional trust practitioner.