By PWC Tax Synopsis
PWC discusses the SCA case of Raath v Nel where Nel had sold his assets toa discretionary family trust in which he was one of three trustees. He was not a capital beneficiary of the trust but was a potential income beneficiary. Nel sued ananaesthetist after a failed surgical procedure.At issue in the litigation was whether Nel had suffered a loss in his personal capacity or whether the loss had been suffered by the trust which held the shares in the company which now owned the business.The court held that Nel had adduced no evidence of any loss suffered by him in his personal capacity.
The decision of the Supreme Court of Appeal in Raath v Nel 2012 (5) SA 273 (SCA) illustrates a hard truth that transactions that are entered into have consequences that need to be understood before committing to agreements.
So, for example, it is hazardous to counsel a person to form a trust and to shift assets into the trust without considering the consequences of doing so. And, as the decision in Raath v Nel shows, a step of this kind can be particularly hazardous where the assets that an entrepreneur transfers into the trust are shares in the company which he uses as the business structure to carry on his trade. For the consequence of doing so is that beneficial ownership of the business then passes out of the hands of the individual founder of the business and into the hands of the trust by virtue of its shareholding.
The transfer of personal assets into a trust is not a mere illusion
It may be tempting to think that forming a company or trust to carry on a business is just sleight-of- hand, that the documents with signatures and official stamps are just legal fairy-floss, and that, in reality, everything will carry on as before. Farlam J warned of this misconception in Nieuwoudt NO v Vrystaat Mielies (Edms) Bpk 2004 (3) SA 486 (SCA) when (giving the judgment of the court) he referred to the trust there in issue as being –
‘typical of a newer type of trust where someone, probably for estate planning purposes or to escape the constraints imposed by corporate law, forms a trust while everything else remains as before’.
The truth of the matter is that, if the parties truly intend that ‘everything shall remain as before’, then the trust is a sham (for there will have been no genuine intent on the part of the founder to divest himself of the assets) and will be treated by the law as such. On the other hand, if the trust is genuine, then it is not the case that ‘everything shall remain as before’ – if the founder has transferred assets to the trust, then they are no longer his assets, and any gains or losses in respect of the assets accrue to the trust.
High Court regarded transfer of assets into a trust as "artificial”
When Raath v Nel was being heard in the High Court, the judgehimself fell into the trap of regarding the formation of the trust and the transfer of assets as being "artificial” and therefore to be disregarded. His judgment was overturned by the Supreme Court of Appeal which remarked that –
‘The trial judge regarded as artificial the approach that the loss to the trust is not in reality that of the respondent. He found that the business and the trust were in reality built up by the respondent for his old age and for posterity and that he had lawful control over the trust. The fact that no dividends had been declared and paid out .. had no relevance when the bigger picture was considered.’
The decision in Raath v Nel
The facts in Raath v Nel 2012 (5) SA 273 (SCA) were that Nel was a successful businessman and the driving force behind his numerous successful business ventures. On professional advice and with a view to reducing estate duty on his death he sold all his assets, including his shares and loan account in a company of which he was the sole shareholder, to a discretionary family trust in which he was one of three trustees. He was not a capital beneficiary of the trust but was a potential income beneficiary.
Nel was, however, in effective control of the trust in that he had the right to remove a trustee and appoint another in the latter’s place.
As a result of a failed surgical procedure which saw him hospitalised for a lengthy period, he neglected the business and its profits declined. Nel sued the anaesthetist in the surgical team for the loss he had allegedly suffered in his personal capacity from those declining profits.
At issue in the litigation was whether Nel had suffered a loss in his personal capacity or whether the loss had been suffered by the trust which held the shares in the company which now owned the business.
In reversing the decision of the High Court, the Supreme Court of Appeal said (at para  of the judgment) that although a trust is not a legal persona in its own right, "the separateness of the trust estate must be recognised”.
Given that the business was now owned by the company whose shares were held by the trust, and given that Nel’s reduced managerial input into the business had impacted negatively on the company’s profits, the question was whether Nel had personally suffered any loss.
The court held (at para ) that Nel had adduced no evidence of any loss suffered by him in his personal capacity; that the court below had erred in upholding his claim for damages in the absence of proof that he had personally suffered any loss as from the date that the trust had been established, and held (at para ) that Nel was entitled to damages for loss of earnings in his personal capacity only for the period prior to the formation of the trust.
Although the decision in Raath v Nel was not concerned with the tax implications of what had occurred, the judgment holds an implicit tax planning lesson, for it is clear that any losses suffered by the trust could not, for tax purposes, have been claimed by Nel in his personal capacity.