A testing time for trusts

The explanatory memorandum to the TLAB specifically states that the new tax proposals pertaining to trusts are there to limit the ability of taxpayers to transfer wealth from one generation to the next, without being subject to tax.

The main focus of attention of the proposed regulations, in respect of trusts, is on interest-free loans or advances with interest below market rates that are made to a trust. In terms of the Bill, the proposed acceptable interest charge is currently 8% per annum. This rate is linked to the South African Reserve Bank repo rate, and is the official rate of interest as determined in terms of the Income Tax Act.

Up until now, many trusts have had assets settled into them by way of an interest-free loan. The donor or lender would peg the value of their estate by way of the interest-free loan and the asset would be free to grow within the trust structure.

This proposed new legislation is currently open for public comment. If passed as law, it will make interest-free loan accounts and finance granted at a lower interest rate than the official rate of interest an extremely punitive measure in respect of the capitalising of a trust.

Existing trusts will have to be reviewed

All existing trust structures with interest-free loans, or those with interest below the official rate of interest, will need to be reviewed by trustees and action taken to determine the most appropriate strategy going forward. There are essentially only four options open to these structures:

• Charge an interest rate, for example 8% per annum, on the loan account. This results in taxable interest income accruing to the lender.

• The lender pays 20% donations tax and donates the loan to the trust, thereby doing away with the credit.

• The trust repays the loan to the lender. This course of action may result in a hefty capital gains tax (CGT) charge for the trust as it realises assets to repay the loan.

• The anticipated new legislation is adopted and the deemed interest is taxable in the hands of the lender.

This proposal will come into effect on 1 March 2017 and applies in respect of years of assessment commencing on or after this date.

Proposed new trust structures will need to be reappraised as to what will be the most appropriate funding mechanism and whether or not a trust is still warranted as the optimum vehicle for the envisaged structure.

A rock and a hard place

High-net worth individuals are essentially being caught between the proverbial rock and a hard place. Do they retain investment and growth assets in their own name and let their estate pay a 20% duty on the market value of these assets at death, but during their lifetime benefit from a more favourable CGT dispensation?

Alternatively, they can donate or lend assets to a trust, and have them excluded from their estate, but pay a higher and more punitive CGT or donations tax. Individuals pay an effective maximum 16,4% CGT; whereas trusts are double that at 32.8%. There is no easy answer to this predicament that faces the wealthy and each case and family situation should be examined on its own facts and merits.

The only good decision is to take professional financial advice and have a strategy that meets the needs of the family and ticks all the regulatory boxes. The only certainty is that whatever option is taken, the new dispensation promises to be more taxing than the current one.