On the 8th July 2016 National Treasury released the much anticipated Taxation Laws Amendment Bill (TLAB). Finance Minister Pravin Gordhan in his February budget speech had made some pretty scary remarks about where he wanted legislation to go as pertaining to trusts. The TLAB gives us a window as to exactly where that legislation is heading. It is no secret that government does not like 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 TLAB proposed regulations is on interest free loans or loans with interest below market rates that are made to a trust. The current acceptable market related interest charge is 8% per annum. 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 and if it passes muster and finds its way into law, will make interest free loan accounts an extremely punitive manner of capitalizing a trust. All existing trust structures with interest free or loans with interest below market rates, will need to be reviewed by trustees and action taken as to what is the most appropriate strategy going forward. There are essentially only 4 options open to these structures:
- Charge an 8% p.a. market related interest on the loan accounts. This results in taxable interest income accruing to the lender, and more often than not, no equivalent tax deduction in the trust.
- The lender pays 20% donations tax and donates the loan to the trust, thereby doing away with the loan.
- The trust repays the loan to the lender. This course of action may result in a hefty CGT charge for the trust as it realizes assets to repay the loan.
- The anticipated new legislation is adopted and deemed interest is taxable in the hands of the lender.
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.
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. Individuals pay an effective max 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 merits. The only good decision is to take professional 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!