In 1986, Billy Joel released his classic song, It’s a Matter of Trust. At that time of life and business, trust practitioners were extremely busy and in great demand. There were significant tax advantages to be had by having a trust, or better still a whole group of trusts. Entrepreneurs and the wealthy were sold family trusts, property trusts, investment trusts, trading trusts and then a holding trust that sat above all the other trusts. These days are now very much in the past, and we currently live and operate in a dispensation were the spotlight is firmly on trusts and their apparent use to avoid paying estate duty and donations tax, as well as income splitting and other tax benefits. It may no longer be a matter of being able to trust in trusts?
Last year the Davis Committee was commissioned to review South Africa’s current taxes on wealth. They released their first interim report in September 2015, and now in the 2016 budget speech delivered by Finance Minister Pravin Gordhan, we have the first of these measures being outlined. In the explanatory notes to the budget speech of 2016 as posted on the South African Government Treasury website it is quoted: “To limit taxpayers’ ability to transfer wealth without being taxed, government proposes to ensure that the assets transferred through a loan to a trust are included in the estate of the founder on death, and to categorise interest free loans as donations.” This is the thin end of the wedge and the note goes on to state that further measures are being considered to limit the use of income splitting and other such like tax benefits that trusts currently afford settlors and beneficiaries.
To avoid paying donations tax of 20%, most trusts are initiated by the founder settling growth assets into a trust by way of a loan account. This loan account is often interest free to prevent taxable income accruing to the lender. The growth assets, if they are shares, generate dividends which are only subject to Dividend Withholding Tax of 15%. These dividends can then be used to repay the loan account and should the lender live long enough, the loan is often substantially reduced. The asset or listed share in this case then grows in the trust and many years later when the founder dies, only the value of the loan outstanding at death is included in his estate. Notwithstanding the fact that the assets may have grown many times over since their original settlement into the trust. The full benefit of this structure is only appreciated when one considers that a R400,000 investment equally into the listed shares Shoprite, Aspen, Naspers and Mr Price will currently be worth R22,5m. This has up until now been the classic legal way of pegging the value of one’s estate and ensuring that the assets pass onto the next generation as efficiently as possible.
Before any drastic knee jerk actions are taken, founders and trustees alike, should wait until the formal Taxation Laws Amendment Bill is published, which is likely to be sometime in June 2016. They will then be able to judge and calculate the effect of the intended legislation on their particular structure. However, it would be penny wise and pound foolish for trust founders and trustees not to take professional advice on these matters as the long term effects could be material.