We have known for quite a while that government is not at all fond of trusts and the manner in which they allow wealth to be efficiently transferred from one generation to the next. This dislike has manifested itself in a number of ways. Trusts are taxed at a flat rate equivalent to the top tier rate that applies to individuals, no tax tables with phased rates at incremental levels. The capital gains inclusion rate is double that of individuals and currently stands at 80%. This means that 80% of a capital gain is taxed as income, making the taxation of income and capital gains in a trust, almost a zero sum game.
Then, in his budget speech earlier this year, the Minister of Finance announced that further measures will be implemented to limit the ability of taxpayers to transfer wealth from one generation to the next without being subjected to tax. In the first draft of the new tax proposals, released on the 8th July 2016, the intention was to implement a deemed interest charge on persons who made interest free loans to trusts, and to tax this as income.
The trust industry made some extremely pertinent comments along the lines that an income tax instrument is being used to address the avoidance of donations tax and estate duty. This comment has been accepted and the new proposal is that the interest foregone on interest free or low interest loans will now be subject to donations tax on an annual basis.
Certain other industry led comments were not accepted. The trust industry had proposed that the new laws only apply to new loans and that existing loans would retain the status quo. This proposal was kicked into touch and not accepted. The new proposals specifically state that the new imputed donations tax will apply to all interest free or low interest loans in existence on 1 March 2017. It was also made clear that it is the intention of National Treasury to retain the attribution rules. Simply put, these rules state that income and/or capital gains that are generated by a trust, as a direct result of the interest free loan, must be taxed in the hands of the lender.
The new proposals are open for comment until the 10th October 2016. Whereupon, all comments will be reviewed and we shall hopefully see the final legislation a short while thereafter. Where does this leave trusts and the people that are connected in one way or another to trusts?
Firstly, it is pleasing to note that National Treasury do take on board serious comments made by the industry and make appropriate adjustments to their envisaged legislative changes. The new proposed legislation represents a slight softening of the stance taken by government. The deemed interest will now only be taxed at a rate of 20%, and not the marginal income tax rate of 41%.
We still hold the following views as pertaining to trusts:
- Nothing should be done until the legislation sees the light of day and becomes the law of the land.
- All responsible trustees would be well advised to seek advice and review the financial status and current standing of the trust in respect of the impact of the new legislation.
- Trustees who do not take any action, and carry on business as usual, may very well be in breach of their fiduciary duty to act at all times in the best interests of the beneficiaries.
- There is still very much a space for trusts to be effectively utilized and they still fulfill a valued role. However, tax should not be the driving motivating factor for the formation and use of a trust.
The 2nd report of the Davis Tax Committee into the future of Estate Planning in South Africa recommends the implementation of further trust anti avoidance legislation. Tax legislation around trusts has up until now been a long and winding road, and frankly speaking, we still a long way to go on this road, with quite a few more bends ahead.