ALL ABOUT TRUSTS
The wealthy were holding their collective breath before this year’s Budget, knowing that the government was desperate to plug a hole in its revenue and create a more equal society, and that it would increase taxes to meet these objectives.
The following interesting comment was made at a post-Budget breakfast briefing: people simply want certainty so that they can plan their finances properly. There are many uncertainties (and threats) affecting people’s tax planning, preventing them from making informed decisions and stabilising their estate planning structures.
For example, since 2009, the government has alluded to the fact that trusts are often used to avoid paying estate duty. Since 2014, the Davis Tax Committee (DTC) has looked at attacking trusts through punitive tax measures. In July 2015, the DTC recommended removing the conduit principle, which is a huge benefit of a trust. In August 2016, the DTC recommended changes to estate duty and donations tax and the introduction of a wealth tax.
All these proposals, as well as recent major tax amendments and uncertainty over what measures may be implemented in future, have made the wealthy, including “trust owners”, wary and unable to plan properly.
With the recent attack on the wealthy in the form of increased capital gains tax (CGT) – through a higher inclusion rate and a higher tax rate – a higher dividends tax rate, a new income tax rate of 45%, and the introduction of a donations tax on deemed interest on interest-free loans made by individuals to trusts, the government would have had a hard time convincing the wealthy to pay even more tax this year. These taxpayers are mobile and can move their wealth offshore and pay (less) tax elsewhere.
As an illustration of the flexibility and mobility of the wealthy, it is interesting to note that, despite the increase in the dividend tax rate last year, the South African Revenue Service (Sars) collected less dividend tax after the increase.
In this year’s Budget, the focus of National Treasury was on collecting money to make up the revenue shortfall and fund expenditure such as free higher education, rather than attack the wealthy in general. It therefore targeted the “low hanging fruit” by increasing the rate of value-added tax (VAT) by one percentage point. It is believed that this measure will do the least damage to economic growth and employment over the medium term. The biggest spenders pay the largest portion of this indirect tax.
With the increase in the VAT rate affecting everyone, including the poor, Treasury had to be seen to be attacking the wealthy by increasing the rate of donations tax and estate duty from 20% to 25% on amounts over R30 million. It is estimated that this year a mere R150m will be generated from the increase in these rates. This is a small amount compared with the additional R36 billion that will be raised through other tax changes, and the expected R204.3bn budget deficit. It will not really help the government to pay for its expenditure.
National Treasury did not adjust the top income tax brackets to account for inflation, which will result in higher-income earners paying R6.8bn more in taxes this year.
South Africa has a progressive tax system, which means that higher-income earners pay a higher rate of tax compared with lower-income earners. In other words, an increase in your salary (often to cater for inflation) may result in you paying income tax at a higher rate than you did before your salary increase.
Sars will also receive more money from the wealthy through increased excise duty on luxury goods.
With the perception that trusts are only for the wealthy, serving as vehicles to reduce or avoid tax, and Sars’s scare tactics since 2014, many people either moved assets out of trusts into their own names or shied away from including trusts in their estate plans.
The focus on avoiding taxes has made people forget the core benefits of a trust, which are:
• Protecting assets, both for yourself during your lifetime (if, for example, you develop a disease such as Alzheimer’s) and for your minor children on your death; and
• Creating continuity and liquidity on your death.
Despite various attempts, the government has not succeeded in removing the conduit principle, which creates flexibility and enables trusts to pay lower taxes than individuals.
The conduit principle allows trustees either to pay income tax (at 45%) or CGT (36%) in the hands of the trust or to distribute the tax liability to the beneficiaries at their marginal rates of tax (income tax rate of 18% to 45%; CGT rate of 7.2% to 18%), thereby paying much less tax, while protecting the assets in the trust and avoiding estate duty. You can legally use this mechanism as part of your tax planning and achieve better tax efficiency than you would in your personal capacity.
You can also apply the “income/capital gains splitting” principle to reduce the effective tax rate on income or capital gains generated in a trust, by distributing them between a number of beneficiaries, using the progressive tax rates to your advantage.
The conclusion is that a trust, although not for everyone, is still an effective vehicle to consider as part of your estate plan.
The increase in the rate of estate duty and the non-adjustment to the top marginal tax brackets may make it worth your while to consider including a trust in your estate plan.
In light of the ongoing uncertainty and the major changes to various taxes, it is advisable to build flexibility into your estate plan. It may be worthwhile to consult a professional who understands trusts and how they fit into an estate plan. You should also educate yourself about estate planning and trusts.
Phia van der Spuy is a registered Fiduciary Practitioner of South Africa and the founder of Trusteeze, which specialises in trust administration.