Author: Amanda Visser (IOL).
Proposed changes to the tax treatment of trusts could bring an end to a common abuse of trusts as a way of reducing estate duty.
National Treasury and the South African Revenue Service (SARS) have increasingly attacked the use of trusts to limit the tax liability of especially the very wealthy through estate planning.
Finance Minister Pravin Gordhan said on Wednesday government proposes to ensure that assets transferred through an interest-free loan to a trust are included in the estate of the founder of the trust at death.
Interest-free loans to trusts will also be categorised as donations in order to limit taxpayers’ ability to transfer wealth without being taxed.
Ettiene Retief, director of FTR Tax and Corporate Administration, says the change comes as no surprise.
SARS recently introduced a revised tax return for trusts with clear disclosure requirements on loans. Taxpayers now have to declare whether the loans are interest-bearing and when the loans will be repaid.
Trustees struggled to submit their returns because, in many instances, they did not have the information required in the revised tax return, says Retief.
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Keith Engel, CEO of the South African Institute of Tax Professionals, says even middle class taxpayers have used trusts to limit estate duty.
A taxpayer will sell a property to a newly formed trust for R1 million. However, the trust has no money, and receives an interest-free loan from the lender, to be repaid over a couple of years.
The taxpayer still has R1 million in his estate because of the loan, but no property. The taxpayer then annually donates R100 000 to the trust, as he is entitled to a R100 000 tax-free donation per year.
The trustees decide to pay back the loan with the same donation. The cash very seldom flows, but the effect is that loan is reduced by R100 000 every year using the tax free donation, until there is no more loan.
Asking questions
Retief says SARS will soon start questioning whether the donation and the repayment of the loan were legitimate and not a mere simulation to reduce the loan balance.
It is unclear when the measures will be implemented. Ernie Lai King, head of Hogan Lovells tax department in Johannesburg, says there is very little detail about the proposed amendment.
He says it would be wise to wait for the draft legislation, expected to be released later this year.
However, he anticipates the changes will only apply to interest-free loans.” I expect that the deemed donation will apply prospectively and not retrospectively. ”
Retief says trusts remain a good way of protecting assets, if done properly. He says, despite the proposed changes, there are still benefits from having the asset in the trust.
The loan account to the trust caps the value of the asset. If there is a loan for a property of R1 million, and the property is worth R10 million when the taxpayer dies, the R1 million loan account forms part of the estate and not the R10 million property.
“I will not encourage people to change what they have, but what I have been saying for years is that if there is a loan truly treat it like a loan with all the elements of a loan.”
That means the loan must have a repayment date, and there must be interest charges.
Alan Seccombe, PwC tax partner, says it will become increasingly more difficult to undertake effective estate duty planning.
“It will potentially still be possible to donate assets to a trust, and pay donations tax. The asset’s increase in value in the trust will be outside the estate duty net, although income attributable to the donation and capital gains made by the trust in disposal of that asset can still be imputed to the donor,” he explains.
This article first appeared on iol.co.za.