Reforming the taxation of trusts: a long time coming

By Johan van der Walt

High Net Worth Individuals (HNWI’s) and their use of trusts for tax and estate planning purposes go hand in hand. A trust is often praised for its “flexibility”. Open any financial planning periodical and there’s bound to be an article on the virtue of trusts.

The “trust” concept originated in English law. It has been called “the most distinctive and creative achievement of English jurisprudence.” It originated during the 12th and 13th century Crusades. English land ownership was a feudal system. A Crusader leaving England would grant ownership of his estate to a trusted acquaintance upon the understanding that his land would be restored to him upon his return. The King’s Courts regarded the Crusader’s land as belonging to the trustee who had no obligation to return same. The returning Crusader could, however, petition the King who referred such disputes to the Lord Chancellor. The Lord Chancellor decided matters according to his conscience and so developed the notion of “equity.” Over time, the Lord Chancellor’s court continuously recognised the returning Crusaders’ claims. The principle developed that the legal owner (the “trustee”) only held the land for the benefit of the original owner (the “beneficiary”) until his return, at which stage the trustee then had to return the land. The term “use of land” was coined and eventually developed into the trust concept.

Local tax principles relating to trusts have been fairly static over the recent past. The fact that trust income attracted a 40% tax rate (and an effective CGT rate of 26.7%) was probably the strongest indicator that the fiscus had a jaundiced view of tax planning via a trust.

The topic of trust reform first featured in the 2012 Budget. Mid- 2012 SARS announced that research showed that a potentially significant number of HNWI’s “… abused trusts to hide their tax liability.” Start April Mr. Bob Head joined SARS as special adviser to the Commissioner. In a Business Day article titled “SA strikes right tax balance to address its challenges” (2 April 2012) he wrote: “Sadly I have never inherited anything and whatever I have I made. I have seen a lot of it disappear in tax. That is just the way it is. I find inherited wealth more difficult to stomach and when the income on that wealth is hidden in trusts and structures to avoid tax, then I really do see red.”

So HNWI’s and their use of trusts have been in SARS’s sights for quite some time. The SARS Strategic Plan (2012/13 2016/17) stated that there was a “compliance risk posed by high-net worth individuals and the use of trusts to conceal their income.” It said that under-declaration of income by persons in the HNWI category (annual income in excess of R7m, alternatively R75m in assets) was wide-spread with “only a fraction” actually declaring their income to SARS. The Strategic Plan announced that trust reform would be prioritised. Although there was no detail, it sounded ominous.

Well SA taxpayers now have the detail.

Minister Gordhan referred in his 2013 Budget Speech to “… various measures proposed to protect the tax base and limit the scope for tax leakage and avoidance.” One such measure was that “… the taxation of trusts will come under review to control abuse.”

In Chapter 3 (p 54) of the 2013 Budget Review the following detail appears:
Certain aspects of local and off-shore trusts have long been a problem for global tax enforcement due to the flexibility and flow-through nature of trusts;
The use of a trust to avoid estate duty has also been of concern and will be reviewed;
The legislative proposals to come will not impact the legitimate needs of minor children and people with disabilities;
The legislative proposals will bring about certain fundamental changes to the taxation of trusts: Discretionary trusts would no longer be allowed to act as flow-though vehicles. Taxable income and loss (including capital gains and losses) would thus be fully calculated at trust level with distributions to beneficiaries acting as deductible payments to the extent of current taxable income. Beneficiaries will be eligible to receive tax-free distributions, except where they give rise to deductible payments (which will be included as ordinary revenue);
Trading trusts will be taxable at the entity level, again with distributions acting as deductible payments to the extent of current taxable income. A trust will be a “trading trust” if it conducts a trade or if beneficial ownership interests in such a trust are freely transferable;
Distributions received from offshore foundations will be treated as ordinary revenue. This amendment is aimed at schemes designed to shield income from global taxation.

The HNWI constituency was spared a wealth tax and there has been no increase in the maximum marginal tax rate.

However, the envisaged tax amendments will impact the SA trust landscape and could derail many a carefully crafted trust structure.

At least, no-one can complain that no warning had been given.