Estate planning: Tax trouble for trusts
19 August 2015
Posted by: Authors: Ruan Jooste and Maarten Mittner
Authors: Ruan Jooste and Maarten Mittner (Financial Mail)
The Davis Committee’s recommendations on the taxation of trusts and estate duties are punitive in their present form, say industry players, and could lead to new forms of legal avoidance.
If the recommendations are implemented, all SA resident trusts and their beneficiaries or donors will be taxed as separate taxpayers
Trusts will be taxed at a flat income tax rate of 41% and an effective capital gains tax (CGT) rate of 27,31%.
The way the trust was funded or constructed, which could minimise tax obligations, will no longer be relevant.
Where offshore trusts are concerned, the distinction between income and capital distributions to SA beneficiaries will fall away. At present they are subject to different tax rates. All payments from the foreign trust will be taxed at the (higher) personal income tax rate applicable to the recipient.
In addition, all income derived by such trusts will be considered a "donation” from an SA resident and subject to the 20% donations tax as defined in the SA Income Tax Act.
Currently and in lay terms, depending on the type of trust — local or foreign — legislation prescribes that income should either be taxed in the hands of a beneficiary (usually a vesting trust) or the trust itself on its income accrued (probably a discretionary trust).
This basic application could change depending on different circumstances and based on certain principles contained in the act. So the taxpayer, the type of tax applicable and the rate payable could all change.
The committee, however, suggests in its first interim report, released on July 13, that many tax benefits applicable to the use of trusts must fall away.
In addition, it has been recommended that the generous allowances to minimise or defer estate duty (currently 20%) on deceased estates should be revisited.
The committee also wants the donations tax rate of 20% to increase.
The removal of the various exemptions and introduction of increases could improve estate duty collections by between R10bn and R15bn from the current R1,486bn, which the committee says will be a useful contribution in reducing national debt levels.
Because of suggestions contained in the report, the efficiency of trusts as an estate planning tool is being questioned. But tax experts say it is too early to call all trusts dead, as some, notably special trusts, will still hold significant benefits. Special trusts for children or people with disabilities, for example, will still be taxed at lower rates.
Eugene du Plessis, Grant Thornton’s tax head in Johannesburg, says the proposed amendments may be simple, but they hold potentially important consequences. He adds that there is no reason for panic just yet.
The proposals are still in draft form and are up for debate. The public has until September to comment. The potential amendments also have to jump through various legislative hoops before becoming law.
Meanwhile, taxpayers might find alternative ways to structure and protect their future nest eggs.
"The best estate planning remains emigration,” says Webber Wentzel director Dan Foster. Many countries do not have estate duty or donations tax.
Estate duty and CGT applicable to a deceased estate discourage long-term savings in this country, Foster says, as the state takes a significant portion of wealth accumulated when a taxpayer dies.
Many people are already considering emigration, so in future trusts will probably be used more as a pre-emigration tool, Foster says, and not a way to manage future tax obligations.
He says liquidating SA investments and sending them abroad on emigration does not help investment and growth in SA. "But this is the impact of high taxation. The state must understand that people and their capital are not obliged to stay in SA, and tax rules should be designed to encourage people to stay,” he says.
Foster adds that the CGT charge (deemed asset disposal on emigration) is part of the problem. It discourages people from bringing capital to SA, as it applies to all assets (excluding real estate), even foreign assets acquired prior to coming to the country.
Other tax experts agree that government cannot legislate individuals into keeping their money in SA. The negative impact of exchange controls on capital flows is proof of that. Not to mention the number of locals with offshore bank accounts, as revealed by leaks from HSBC Bank’s Swiss subsidiary. The Davis Committee’s attempts to discourage offshore trust formation, by raising foreign trusts’ potential tax bills, will also force capital flow elsewhere.
Another potential hindrance to attracting foreign investment and boosting local savings — and probably an unforeseen consequence of the recommendations — is the fact that trusts are not only used by individuals but by companies as well.
For example, trusts are used to facilitate a portfolio of investments, such as a collective investment scheme.
Hanneke Farrand, a tax director at ENS, says that although corporates are not dealt with in the committee’s report, a broad-brush amendment of established principles would naturally also affect these arrangements.
"It is hoped that during this extensive consultative process, solutions can be found to the issues identified in the report without adopting the punitive tax measures contained therein,” Ferrand says.
This article first appeared on financialmail.co.za.