By Francois van Gijsen
What are the potential implications for ‘trusts’, now that Minister Gordhan intends amending their alleged ‘tax avoidance’ aspects?
Regarding trusts, the question most frequently asked by clients these days is this: “Do you think that trusts still have a role to fulfill in estate planning”? I anticipate hearing much more about this topic in the coming weeks as the proposals contained in the 2013 budget speech start siphoning through to all who wish to use trusts as a financial planning tool. We will understand it better if we take a look at recent history and the tax treatment of trusts (excluding special trusts).
I would imagine, when in 1991 it was found that a ‘trust was not a person’ for income tax purposes in the case of the “Trustees of the Philip Frame Will Trust v CIR ”, that many aspiring estate planners couldn’t start utilising trusts soon enough. What I do know is that as a result thereof, the legislature swiftly amended the Income Tax Act to include trusts in the definition of a ‘person’ in relation to the tax net.
Furthermore, a look at the SARS Guide for Tax Rates/Duties/Levies shows the following:
- Between 1999 and 2011 trusts, excluding special trusts, have consistently paid transfer duty at a higher rate than individuals
- From 1998 to the present, trusts have consistently paid income tax at a higher rate than individuals
- From the inception of capital gains tax (CGT) in 2001, trusts have consistently paid CGT at a higher rate than individuals.
One could easily draw the conclusion that trusts are disliked (or maybe liked too much) by the SARS. In his previous budget speech (2012) Minister Pravin Gordhan issued a warning to trustees, advisors and tax practitioners, saying that: “Poor tax compliance is also apparent in respect of trusts and in parts of the construction sector, and the role of tax practitioners and other intermediaries will come under scrutiny.” I would hazard a guess that it is this poor compliance and SARS’ perception that trusts are used for tax avoidance that is driving its most recent scrutiny of trusts.
The following quote from the judgement of Thorpe v Trittenwein also reveals a growing impatience on the part of the courts with regard to the fast and loose manner in which those using trusts treat this legal form: “Those who choose to conduct business through the medium of trusts of this nature do so no doubt to gain some advantage, whether it be in estate planning or otherwise. But they cannot enjoy the advantage of a trust when it suits them and cry foul when it does not. If the result is unfortunate, Thorpe has himself to blame.” It seems though that the Treasury has decided to put an end to the abuse of the trust form for the purposes of tax avoidance once and for all.
In the Budget Review, 27 February 2013, the following comments in regards to trusts can found:
“To curtail tax avoidance associated with trusts, government is proposing several legislative measures during 2013/14. Certain aspects of local and offshore trusts have long been a problem for global tax enforcement due to their flexibility and flow-through nature. Also of concern is the use of trusts to avoid estate duty, which will be reviewed. The proposals will not apply to trusts established to attend to the legitimate needs of minor children and people with disabilities.”
Many people associate good financial planning and estate planning with obtaining a tax saving. What a great pity that the trust concept is being ‘bastardised’ to the extent that many people only consider its tax treatment when deciding whether a trust is a viable financial planning tool. But why is using a trust for tax purposes ’bastardising’ it?
The following characteristics of a trust can be gleaned from the definition of a Trust in the Trust Property Control Act , being the common law and case law. Firstly, it requires you to hand over your assets to the trustees and to fully divest yourself of the ownership thereof. Secondly, the assets handed to the trustees are not to be used by them for their own benefit, but to be administered for the benefit of a beneficiary or group of beneficiaries. Thirdly, the trust is to be administered in accordance with the terms of the trust agreement. To summarise, the trust form is actually intended as a means to care for or benefit persons other than the donor or the so-called ‘financial planner’.
To return then to the original question, if the trust is to be used in an attempt to avoid tax, then it is doubtful that trusts will in future satisfy the planner’s expectations. In the past, one of the main ways in which trusts were used to obtain a tax advantage was through the use of the conduit effect codified by section 25B and Paragraph 80 . This was done by vesting the trust income or capital gain for the tax year in favour of the trust beneficiaries. In so doing, these would be taxed in the hands of the beneficiary rather than the trust. The Treasury intends in future to prevent trusts from acting as conduits in this manner, as stated: “Discretionary trusts should no longer act as flow-through vehicles. Taxable income and loss (including capital gains and losses) should be fully calculated at trust level with distributions acting as deductible payments to the extent of current taxable income. Beneficiaries will be eligible to receive tax-free distributions, except where they give rise to deductible payments (which will be included as ordinary revenue).”
It is of course impossible, at this stage, to know what amendments will be made to the Act in the process of bringing about these changes, but it seems reasonable to assume that both section 25B and Paragraph 80 will be deleted. I’m concerned to hear that – within two days of the budget speech – a broker is advising his clients that to circumvent these changes, they simply need to ensure that the deeming provisions of section 7 and paras 68 – 73 are applicable, thereby ensuring taxation of receipts in the hand of the donor – presumably at a lower tax rate.
Besides the risk that decisions based purely on considerations of tax avoidance may be attacked under the general anti-avoidance provisions, this ‘solution’ is still flawed. It will mostly be too late for tax planners to access this supposed solution for existing trusts as the purpose and intended advantages of these trusts will already be determined. Only when establishing new trusts is it possible to define the trust object in such a way as to place the resulting donation in trust within the ambit of the aforementioned sections.
I would think too that there is a very real chance that, along with the potential removal of section 25B and Paragraph 80, section 7 and paras 68 – 73 may likewise be removed.
This will certainly be in keeping with Treasury’s stated intention of ensuring that trusts’ taxable income and loss are “fully calculated at trust level”. In conclusion, the effectiveness of trusts as a means of reducing your tax liability has largely been curtailed. However, should the planner wish to use the trust for its intended charitable purpose, it is still a useful estate planning tool. It offers the planner a means of benefitting designated beneficiaries, while the trustees who administer the assets on their behalf offer a measure of protection, both from the potential squandering tendencies of beneficiaries, and from potential creditors. In allocating trust income and capital, trustees will continue having much flexibility to adapt to the changing circumstances and needs of beneficiaries, thereby offering the planner considerable peace of mind. It seems then that the trust form will indeed remain a useful tool.
Francois van Gijsen, CFP, FPSA, BProc, LLM (Tax Law) is Director of Legal Services at Finlac Risk and Legal Management.
This article was originally published in the April 2013 issue of ASA.