Pro­posed tax amend­ment could see trusts ‘be­ing closed down’

‘Sell­ing’ an as­set to a trust us­ing an in­ter­est-free or low-in­ter­est loan will no longer be a tax-friendly op­tion if an amend­ment to the In­come Tax Act is passed into law. re­ports

Weekend Argus (Saturday Edition) - - GOODPUZZLES -

The abil­ity to make in­ter­est-free loans to trusts that can be re­paid or writ­ten off over a num­ber of years, and the sav­ing on es­tate duty and do­na­tions tax that arises from these ar­range­ments, will end in March next year if a pro­posed amend­ment to the In­come Tax Act is passed into law.

The pro­posed amend­ment, which was re­leased this month in the Tax­a­tion Laws Amend­ment Bill, aims to close the loop­hole that al­lows you to avoid es­tate duty by plac­ing an as­set, such as an in­vest­ment, in a trust.

At least one tax firm has warned that the change is suf­fi­ciently far-reach­ing to re­sult in trusts be­ing closed down.

David Warneke, the head of tax tech­ni­cal at BDO South Africa, says the pro­posed amend­ment will, if passed into law, mean that from March 1 next year:

• Some­one who makes an in­ter­est-free or low-in­ter­est loan to a trust will be deemed to be li­able for in­ter­est at the of­fi­cial in­ter­est rate, or, in the case of a low-in­ter­est loan, the of­fi­cial rate less any ac­tual in­ter­est charged. The of­fi­cial in­ter­est rate is one per­cent­age point above the repo rate and is cur­rently eight per­cent a year.

• This in­ter­est will be tax­able in the hands of the lender, and the founder of the trust will not be able to use the an­nual ex­emp­tion on in­ter­est in­come to re­duce his or her tax li­a­bil­ity.

• The trust will not be able to deduct the deemed in­ter­est from its tax­able in­come.

• The lender will not be able to use the an­nual R100 000 do­na­tions tax ex­emp­tion to write down the loan.

• The in­come tax paid by the lender as a re­sult of in­clud­ing the deemed in­ter­est in his or her in­come must be re­cov­ered from the trust within three years of the rel­e­vant year of as­sess­ment, or it will be treated as a do­na­tion to the trust and the lender will be li­able for do­na­tions tax.

You may also be re­garded as hav­ing made a loan to a trust if you are a “con­nected per­son”. For ex­am­ple, if a com­pany made the loan to the trust, and you own more than 20 per­cent of the shares in that com­pany, you are a con­nected per­son, Warneke says.

He says there is lit­tle doubt that if the pro­pos­als are en­acted, trusts will no longer be as at­trac­tive from a tax per­spec­tive. How­ever, sav­ing on tax should not be the main rea­son for set­ting up a trust. Es­tate pro­tec­tion and plan­ning should be key rea­sons, he says.

Both Warneke and Matthew Lester, a pro­fes­sor of tax at the Rhodes Busi­ness School, warn that ter­mi­nat­ing a trust may trig­ger cap­i­tal gains tax (CGT) on the dis­posal of the trust’s as­sets and re­sult in an in­crease in the value of the per­sonal es­tates of the ben­e­fi­cia­ries, which could in­crease their li­a­bil­ity for es­tate duty. Lester is also a mem­ber of the Davis Tax Com­mit­tee, which is re­view­ing South Africa’s tax pol­icy.


Lester says the pro­posed amend­ment sig­nal the be­gin­ning of a clean-up of how trusts are taxed and mean that peo­ple with trusts can no longer take the tax sav­ings for granted.

Warneke says it could ef­fec­tively re­sult in dou­ble tax­a­tion.

He cites the ex­am­ple of a founder who lends cash to a trust on an in­ter­est-free ba­sis. If the trust in­vests the cash and earns in­ter­est from it, the in­ter­est will be taxed in the hands of the trust, or in the hands of the founder or ben­e­fi­cia­ries if the in­ter­est is dis­trib­uted to them.

In ad­di­tion, the founder will, in terms of the pro­posal, be taxed on in­ter­est on the out­stand­ing loan at the of­fi­cial in­ter­est rate each year, while the trust can­not claim a deduction for the deemed in­ter­est, Warneke says.

He is also of the view that more than one per­son may be re­garded as a con­nected per­son and hence li­able for the deemed in­ter­est and the tax on it.

Re­spond­ing to the pro­posal, if it is en­acted, by ter­mi­nat­ing your trust would be “a dras­tic step”, Warneke says.

Lester warns you should be very care­ful if you plan to un­wind a trust, be­cause you will in­cur CGT, and you could be li­able for trans­fer duty if the trust owns res­i­den­tial prop­erty.

In terms of t he trust deed, trus­tees must al­ways con­sider the best in­ter­ests of the ben­e­fi­cia­ries be­fore a trust can be ter­mi­nated pre­ma­turely.

An al­ter­na­tive, if the trust has enough liq­uid­ity, may be for the trust to re­pay, fully or partly, the low- or zero-in­ter­est loan, but this could have es­tate duty con­se­quences for the lender, he says.

The lender and the trust could, de­pend­ing on the terms of the loan agree­ment, rene­go­ti­ate the terms, so that the lender would charge in­ter­est on the loan at the of­fi­cial rate, Warneke says. The trust would then have an in­ter­est ex­pense, which, de­pend­ing on the as­sets held and, in par­tic­u­lar, the in­come earned by the trust, could be de­ducted from its tax­able in­come. The lender would have an ac­tual amount of in­ter­est against which he or she could use the an­nual in­ter­est ex­emp­tion.

If the amend­ments are en­acted, Lester says the con­se­quences will de­pend on the type of as­sets held. If the trust holds listed shares or a prop­erty, there will be lit­tle room for it to deduct the in­ter­est paid on the loan.

How­ever, if the trust is the owner of a busi­ness, it can po­ten­tially claim a mar­ket-re­lated in­ter­est charge, he says.

If the amend­ment is passed, trus­tees, trust founders and ben­e­fi­cia­ries will have to ob­tain pro­fes­sional ad­vice on how to pro­ceed, he says.

Warneke says a num­ber of “con­tro­ver­sial” pro­pos­als re­lated to trusts were in­cluded in the Davis Tax Com­mit­tee’s first in­terim re­port in July last year. The fi­nal re­port has not yet been re­leased.

The com­mit­tee did, how­ever, rec­om­mend that where fi­nan­cial as­sis­tance or in­ter­est-free loans were ad­vanced to a trust, there should be no at­tempt to make trans­fer pric­ing ad­just­ments – set­ting the price of goods or ser­vices sold be­tween re­lated en­ti­ties. Warneke says the cur­rent pro­posal ap­pears to fly in the face of this rec­om­men­da­tion.

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