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Are trusts still relevant?

25 March 2014   (0 Comments)
Posted by: Author: Bernard Sacks
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Author: Bernard Sacks (Mazars)

During the 2013 National Budget Speech Minister of Finance, Pravin Gordhan ended years of speculation and forecasting about SARS regarding trusts as tax avoidance vehicles when he announced that the current system for the taxation of trusts was to be reviewed and refined in order to prevent an erosion of the tax base. 

Although the Budget Speech did not provide exact details of the proposed changes, the main proposal was that the long established common law flow-through principle would be curtailed. 

In terms of the flow-through principle, income flowing in and out of a trust was regarded as having retained its nature. For example, interest earned by a trust could be distributed as interest to the beneficiary, and likewise for other types of income such as rental, dividends etc. Based on the Budget Speech comments this would come to an end in a manner that treats all income as that of the trust and that any income distributed would be taxed in the hands of the beneficiary as taxable income from the trust despite the underlying make-up of said income.

The Minister made special mention of Trading Trusts, and indicted that these will be regarded as ‘all trusts that conduct a trade or where the beneficial ownership can be freely transferred’. This may be some indication that Trading Trusts may be subject to more changes than would otherwise be the case. 

The planned changes have not yet been implemented - to give National Treasury time to evaluate and consider the proposals in more detail and take into consideration the views of interested parties. The matter might also be referred to the Davis Commission of Enquiry into the Tax Structure of South Africa (a commission chaired by Judge D Davis). 

The mention of planned changes, albeit in the above paraphrased broad strokes, has elicited a knee jerk reaction from various taxpayers and advisors; with comments suggesting trusts will lose their relevance and should possibly be avoided and, structures where trusts are prevalent should be undone by transferring assets to companies or other holding vehicles. 

Should this be the main concern within a group of companies that contains trusts, it may well be indicative that SARS is correct in wanting to tighten the reins on the taxation of trusts as tax avoidance would seem to be the overriding consideration in the make-up of those groups?

However, is that not more a case of the tax tail wagging the business or financial dog? In our view tax planning forms part of sound business and financial planning as tax is a cost that needs to be factored in and reduced where legally possible to increase returns. It should however never be the main or sole reason for entering into any transaction, and similarly the use of a trust should also not have as its sole or main reason the avoidance of tax.  

Trusts are still relevant – they must just be used for the purpose for which they were intended. Where structures involve trusts as vehicles for asset protection, estate planning (as opposed to estate duty planning) and financial planning we submit trusts will remain relevant. The fact that trusts may have, or are providing some tax benefit should have been the result rather than the reason for establishing the structure. 

For an entrepreneur planning to expand his business, build wealth and create an asset base, the use of trusts as the wealth building vehicle outside the actual business makes a lot of sense. An entrepreneur, more often than not, must sign personal surety for business debts, may get involved in business ventures that do not realise their initial potential or may be subject to quality and warranty claims from customers for faulty workmanship on parts and goods that were imported. The trust is a useful vehicle for insulating assets.

As the accumulation of wealth begins, matters such as family dynamics, succession and wealth distribution become the areas of focus. The problems are myriad – but the solution need not be. A carefully structured trust provides the perfect vehicle where the wealth generated by the business can be legally channelled so that growth assets can be acquired and wealth accumulated in the trust. 

These assets will be protected from business creditors; the trust will continue to exist after the death of the entrepreneur and, if administered correctly, would be able to provide some form of maintenance for the remaining family regardless of their own financial independence.  

That being said the administration and governance of trusts is becoming increasingly more important, and persons forming trusts and their trustees should ensure good governance in respect of trust assets and transactions at all times to avoid the failure of the plan due to poor administration of the trust. 

Are trusts still relevant? They most definitely are, as long as they are used for proper business and financial planning. They may not be relevant for tax avoidance – but then again they never should have been.


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