Taxing measures to curb trust fund tricks
29 March 2016
Posted by: Author: Maarten Mittner
Author: Maarten Mittner (BDlive)
The tax efficiency of trusts may have taken a knock after the latest budget proposals, but trusts are likely still to remain viable wealth-preserving instruments.
Some analysts have raised alarm at the possible negative consequences of the new proposals, but others remain optimistic. The days of using trusts to avoid tax or reduce a tax burden, however, may be over.
Finance Minister Pravin Gordhan had harsh words for trusts in last month’s budget. In the review, he said the government’s aim was to keep the tax system progressive. Some taxpayers used trusts to avoid paying estate duty and donations tax, the review said.
The proposed changes will effectively close the gap between individual and trust tax rates, says Citadel’s fiduciary specialist, Jan Dawid Luttig. "So, there will be no advantage in moving assets or income into or out of the trust to maximise a tax benefit."
Despite this, trusts still play an important role for families and individuals who have wealth they wish to preserve for future generations, Mr Luttig says
The use of interest-free loans as payment for the transfer of assets to trusts has come under fire. When an individual sells a R1m asset to a trust, any appreciation in value to, say, R10m over time is excluded from the estate of the individual. That is because the R1m is financed by an interest-free loan from the trust and is an asset of the trust, not of the estate.
To limit taxpayers’ ability to transfer wealth without being taxed, the government proposes to ensure the assets transferred through a loan to a trust are included in the estate of the founder at death, and to categorise interest-free loans in trusts as donations.
"This will result not only in donations tax, but also the imputation of income in the hands of the donor," says Emil Brincker, who is a director at law firm Cliffe Dekker Hofmeyr.
He says measures will also be introduced to avoid income splitting in circumstances where the income of a trust is, for instance, vested in spouses and children.
"These measures are expected to be the first of many that will focus on trusts and perceived avoidance," Mr Brincker says.
Different taxes come together in a trust. Estate duty is levied at death in a testamentary trust at 20%, with a vital element that the deceased is presumed to have disposed of his assets the day before he passes away, thus also triggering capital gains tax.
Donations tax is levied at 20% in a living trust, with a tax-free limit of R100,000.
Last July, the Davis tax committee proposed that trust income, which is vested in the hands of beneficiaries, must fall away. The committee was critical of the use of estate duty measures in tax planning, and said the system contains generous allowances that enable most estates to be subject to capital gains tax and to estate duty only after the death of both spouses. "This defers estate duty collection for many years," the committee said.
The proposals in the February budget are mainly about capital gains tax. This is added to taxable income, but has up to now been a relatively lesser tax calculated by an inclusion rate for individuals of 33.3%, now 40% and excluding special trusts. For companies, the rate is 80%, up from 66.6%.
The new effective rate is 16.4% for individuals, calculated by multiplying the 40% with the marginal rate of 41%.
BDO accounting firm’s tax partner, David Warneke, says too often, trusts are viewed simply as tax-avoidance arrangements. To regard capital lent as a donation is inconsistent with the meaning of the word donation, as it is an amount that has to be repaid.
"If the proposal of the Davis committee to tax all revenue and capital gains in a trust is enacted, the overall tax effect would be disastrous," he says.
Assets would be exposed to estate duty of 20% and capital gains tax at 32.8% if an asset is sold by the trust. Assets held by individuals will attract the 20% and only 16.4% capital gains tax, Mr Warneke says.
With these increases, the government aims to get additional revenue of R1bn from individuals and another R1bn from businesses. This does not seem to be a heavy tax burden, but First National Bank wealth manager Tony Barrett says individuals and trusts could see a sharp tax spike, especially if the base cost was low.
The base cost can be subtracted from the selling price before capital gains tax is calculated. In an extreme case, with the base cost at only R100,000, Mr Barrett has calculated a trust could pay R1.3m more tax.
This would happen if a trust’s share value amounts to R22.5m and R5.9m capital gains tax is paid in current circumstances on asset realisation. Under the new dispensation, capital gains tax rises to R7.2m, higher than the R3.6m payable by an individual under similar circumstances.
One thing seems clear: it will be less appropriate legally to avoid tax through a trust in future.
This article first appeared on bdlive.co.za.