Published: January 2017

Trusts have helped structure estates in the past, and will continue to do so in the future

Trusts, and specifically discretionary trusts or family trusts, have historically been used as an estate planning tool. They have provided individuals with an opportunity to 'freeze' their estates, for the purpose of estate duty, during their lifetime by selling growth assets to a trust. The assets are replaced in the estate of the founder by the loan account, while all future growth happens in the trust. In a discretionary trust beneficiaries are not entitled to the assets or income of the trust. This means a beneficiary's creditors cannot attach the trust's assets if any beneficiary is declared insolvent, and the trust assets will not form part of the founder's estate when he/she dies.

The current tax regime allows the flow of income and capital gains generated in the trust to beneficiaries, thereby providing a means of tax planning. If the Davis Tax Committee (DTC) recommendations are implemented, this will no longer be possible. However, this does not mean that trusts are no longer an important tool in an estate planning exercise.

DTC recommendations in relation to the taxation of trusts

We must emphasise that these are only recommendations and not official policy. National Treasury will consider the recommendations and if it finds them acceptable, they will be adopted into the normal budget and legislative processes that enable further public comment. However, National Treasury has so far opted not to follow the DTC recommendations on interest-free loans to South African trusts and accordingly a new section 7C in the Income Tax Act (likely to take effect from 1 March 2017) has been introduced. This is focused on interest-free loans to trusts that has been addressed in the Draft Taxation Law Amendment Bill of 2016.

Other recommendations in the DTC report include:

1. National Treasury should consider extending section 3(3) of the Estate Duty Act, 45 of 1955, to include 'deeming' provisions that identify 'deemed control' of a trust through a loan account between trusts and connected persons where the interest rate is not subject to an official rate (or is below the official rate). The DTC has suggested that this arrangement gives connected persons de facto control over the trust. (National Treasury has indicated that the introduction of the new section 7C will address this concern.)
2. All trust arrangements should be examined by the South African Revenue Service (SARS) to reduce aggressive tax planning through the use of trusts and to ensure that a legitimate trust arrangement exists. This includes recommending that SARS develop risk-profiling mechanisms to identify and examine trust arrangements.
3. Donors and beneficiaries of vested trusts will be subject to stricter disclosure requirements and enforcement measures.
4. As regards deceased estates SARS should examine trusts in which the deceased enjoyed a vested interest to ensure that, for income tax and estate duty purposes, all income and capital have been accounted for.
5. Only where a trust deed confers on its beneficiaries an indisputable and irrevocable vested right to the capital and income of a trust, should the income (including any capital gains) be taxed in the hands of the beneficiary.
6. The comprehensive examination of foreign trust arrangements should not be confined to the application of the Income Tax Act only when vesting or distribution occurs. SARS should also examine the substance of arrangements before vesting or distribution. Information sharing between tax authorities may well be the starting point for such investigations.
7. SARS should establish a separate investigations unit to examine foreign trust arrangements thoroughly. Where disclosure deficiencies are detected, the penalty provisions of the Tax Administration Act, 28 of 2011 ('TAA'), should be rigidly applied.

Given the extent of the proposed changes, what is the future of the family trust?

From the above it is clear that the DTC is suggesting both a limitation of the perceived tax benefits associated with trusts and, importantly, an increase in the administration and reporting relating to trusts. However, the nature and extent of the other DTC recommendations give rise to the question: is there still a purpose for establishing a family trust?

Family trusts are flexible and versatile structures and offer many benefits beyond tax

Family trusts are seldom established purely for tax benefits, and other purposes typically include:

• protection of and financial assistance to family members who are unable to manage their affairs adequately (for example minor children);
• protection from creditors;
• protection from divorce;
• managing assets for beneficiaries with different needs and demands;
• confidentiality;
• ownership of complex assets and affairs;
• continuity after the death of the founder; and
• business succession.

Where trusts have been set up for these purposes, the intention and benefit of a trust remains valid and appropriate.

Trusts will be under the spotlight to ensure that there is no tax abuse

The DTC has recommended that, in addition to the proposals by the DTC, there should be a review of trusts against existing tax returns submitted to SARS. The DTC has drawn attention to the fact that the records of the various offices of the Master of the High Court indicate some 333 465 active trusts, whereas only 100 590 income tax returns were submitted for trusts. There are further discrepancies, such as 208 trusts that pay salaries that cannot be matched to an employee number. In a financial climate where National Treasury is looking for ways to reduce the budget shortfall it appears that existing trusts are being analysed for non-compliance with existing tax laws.

If you have a family trust, you may need advice to ensure that it is future proof

To give effect to the review recommendation SARS will need to implement new systems. Implementing this recommendation will place great scrutiny on the management and administration of trust arrangements, making a legitimate trust arrangement even more important (such as having a truly independent trustee, and ensuring that there isn't any abuse of the trust, that the trust doesn't function as an alter ego of the founder and that there is good governance). There can be no doubt that loose trustee arrangements are unlikely to withstand scrutiny, and it is advisable to start taking proactive steps (such as a trust audit) to ensure that existing trusts are future proof. The importance of a truly independent trustee who understands good governance and the way a proper trust arrangement should operate is of greater importance now than ever before.

Family trusts could arguably be even more important for estates worth over R15 million

Considering the recommended removal of spousal rollover relief [section 4(q)] as well as the portability of the unutilised portion of the abatement of the first deceased spouse (section 4A) to the surviving spouse (with an increased threshold to R15 million), the DTC recommendations would make trusts unnecessary for estate planning for the middle class (thereby reducing the administrative burden since estate duty isn't an issue below R15 million). However, it could also be argued that trusts are about to become even more relevant for wealthy individuals whose estates exceed R15 million. This is because there is potential for duplication of estate duty when the first dying's assets are bequeathed to a surviving spouse, which would be avoided if the same estate was bequeathed to a trust where the beneficiaries include the surviving spouse and the next generation. Section 7C relates to a mechanism to encourage loans to trusts to carry at least the official rate of interest will not be applicable in testamentary arrangements of this nature as there won't be outstanding loans.

The proposals simply highlight the need for ongoing estate planning and management

Once again, it must be stressed that these are only recommendations and, in the absence of draft legislation and/or budgetary proposals to change the status quo, it is not advisable to make decisions (such as whether to terminate the trust) that alter current planning. However, it is important to keep abreast of developments. There will still be a future for family trusts, but these are likely to be useful only for wealthier clients with assets of more than R15 million (unless special circumstances apply), but more formal management and administration will need to be in place.

Please speak to your regional fiduciary specialist about how we can help you if you have any questions about an existing family trust, or if you think you may benefit from establishing one.

DISCLAIMER The Fiduciary Focus Newsletter is intended for general information purposes only and should not be construed as tax, legal or accounting advice. This communication is based on our bona fide interpretation of legislation, rules, regulations and publications. Nedbank Private Wealth provides estate and tax planning advice; however, we do not provide tax, legal or accounting advice and you are requested to consult a professional tax advisor or professional in this regard.