SO WHAT IS THE FUTURE OF TRUSTS?

A2_bOne of the questions that we are most confronted with by our clients is what the future of trusts are in South Africa.  Some questions even point to the misconception that the trust instrument itself as legal form is on the verge of being scrapped in South Africa altogether!

The current debate raging is not at all that dramatic, although the consequences for taxpayers potentially may be.  The “crystal ball” gazing exercise which we are so often requested to undertake stems from repeated warnings (some less subtle than other) by the Minister of Finance that the use of trusts as a tool to minimise tax exposure, be it in the form of income tax or estate duty, is being revisited by National Treasury to try and find a solution to the perceived abuse thereof.  As recently as in the 2016 budget, the following statement is made:

“Some taxpayers use trusts to avoid paying estate duty and donations tax. For example, if the founder of a trust sells his or her assets to the trust, and grants the trust an interest-free loan as payment, donations tax is not triggered and the assets are not included in his or her estate at death. 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 at death, and to categorise interest-free loans to trusts as donations. Further measures to limit the use of discretionary trusts for income-splitting and other tax benefits will also be considered.”

This alludes both to how trusts are commonly used to minimise tax obligations, as well as how Treasury intends to (what could be considered a more focused) approach to trusts in future, while also hinting at what may be expected going forward.

As a first comment, trusts are popular estate duty planning instruments.  Without going into too much detail, typically an individual will sell his/her assets to a trust on interest free loan account.  In the coming years, the value of the assets will increase in the trust, while the value of the loan account will remain the same in the hands of the individual.

Secondly, trusts are potentially useful for income tax planning purposes as they allow for income to be distributed to individuals that are subject to tax at rates more beneficial than that of the trust (which involves ‘income-splitting’ referred to by Treasury above).  Typically these distributions often contains a fictitious element through distributions made on interest free loan account only (with no real intention that such distributions should vest in the beneficiaries).

It would appear as though Treasury is no longer considering an ‘out-and-out’ onslaught on the taxation of trusts (although this is only speculation).  However, the recent budget perhaps betrays what may be expected and that anti-avoidance legislation is to be introduced that will focus only on abusive practices involving trusts.  For both estate duty and income tax structures involving trusts, it is not farfetched to expect to see provisions introduced into tax legislation which will ensure that loan accounts with trusts all bear interest.  The significance of this?  Interest receipts are subject to income tax.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)

ASSET-FOR-SHARE TRANSACTIONS: TAX FREE RESTRUCTURE

A1_bThe Income Tax Act, 58 of 1962, contains several so-called ‘group relief’ provisions in terms whereof corporate restructures can take place on a tax neutral basis.  One of these is if a transaction comprises an ‘asset-for-share transaction’, or put simply:  where a company purchases an asset in exchange for which that company agrees to issue shares to the seller.

The term ‘group relief’ is somewhat of a misnomer in that not all of the group relief provisions necessarily involve groups of companies.  The ‘asset-for-share transaction’ is one such an example where company groups are not necessarily involved.  In fact, the concession (in section 42 of the Income Tax Act) is quite often used by individuals who are seeking to incorporate their businesses whereby they would transfer said business into a company in exchange for the latter issuing them with ordinary shares in that company.  Such a transaction would not give rise to any immediate income tax costs, nor to any ancillary taxes such as VAT, Securities Transfer Tax, Transfer Duty, etc. (on condition that the relevant required formalities are observed).

The effect of an ‘asset-for-share transaction’ is effectively that the cost of the assets transferred are ‘inherited’ by the company.  For example, assume Mr A has an asset with a base cost of R10 which is worth R100 today.  He is able to transfer that asset to the company in exchange for shares without incurring any tax liability, but the company will be deemed to have acquired that asset at R10, and likewise Mr A his shares at the same price.  The effect therefore is that when one day Mr A should sell his shares, or the company the asset, the capital gain on the original R10 cost would still be realised and consequently taxed at that stage.  The tax implications linked to the asset is therefore not avoided altogether, but merely postponed.

A few requirements to qualify for a section 42 transaction includes:

  • The person to whom the shares are issued (i.e. the person selling the asset) must hold a ‘qualifying interest’ in the company subsequent to the transaction being concluded (being most often at least a 10% interest held in the company);
  • The company and the person disposing of the asset must typically hold the asset with the same intent. In other words, if the company will hold the asset as trading stock, then so too must the person disposing thereof have held the asset as such; and
  • The asset must be worth more than its base cost at time of the transaction being concluded.

Admittedly, this may be quite complex.  To make matters worse, the provisions of section 42 apply automatically if its prerequisites are met and taxpayers are required to specifically elect out of its provisions if it does not want it to apply.  All the more reason why any restructure would be incomplete without a review by a tax expert first before implementation thereof.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)