More refined way to get tax from trusts
Treasury proposes extreme ways when market-related transactions would do, writes PETER DACHS
THE Treasury and the Davis Tax Committee seem to be protagonists of a #TrustsMustFall movement. Trusts, like Cecil John Rhodes, whose statue inspired the #RhodesMustFall movement, form part of our colonial heritage and were introduced to SA after the British occupation in 1806.
The Davis Tax Committee, in its first interim report on estate duty released late last year, identifies trusts as vehicles used to escape tax.
It states that the ability of a trust to vest income or capital gains in its beneficiaries means that “taxpayers are currently almost in a position to freely divert income (both capital and revenue in nature) away from trusts, to be taxed in the hands of beneficiaries with lower effective rates of tax”.
The report also points to the problems of interest-free loans, and states: “Many assets are transferred into trusts, allowing the transfer consideration to remain outstanding by way of an interest-free loan account. These amounts are then gradually repaid as and when cash becomes available to the trust.
“This effectively results in the gradual dissipation of a taxpayer’s estate over a prolonged period, in turn, ultimately dissipating the taxpayer’s estate prior to death.”
In such circumstances, the lender is typically a related party to the trust and its beneficiaries.
Of course, advancing interest-free loans also means that the lender is exempt from paying tax on any interest unless the tax rules impute interest on the loan. The Davis Tax Committee report points out that a deemed interest return is not always imputed to the lender in terms of the Income Tax Act, 1962. as well as other tax benefits in respect of distributions made by trusts should also be considered.
Two major themes of both the Davis Tax Committee report and this year’s budget, therefore, relate to interest-free loans advanced to trusts and the ability of a (discretionary) trust to vest income and capital gains in its beneficiaries where tax is suffered at its (lower) effective rates.
The problem lies with the interest-free loans, and not with the nature of a trust.
For example, if someone offered me an interest-free loan to acquire a basket of listed shares, where the amount owing under the loan is effectively reduced in circumstances where the value of the shares is reduced, I would think I had won the lottery.
I would get all the upside of any value increase in the equity portfolio with none of the downside risk. I would also get free money in that I would be able to keep all the dividends on the shares, without having to pay interest on the loan. This is clearly a transaction that is not market-related.
However, if I were offered a market trade in terms of which I could borrow money at market-related interest rates and would have to provide sufficient security to the lender, then — unless I was a bullish hedge fund manager — I would think very carefully about the transaction.
After all, this is the oldest trade in the book — leverage.
In a market-related transaction, the interest rate would be high, to price in the borrower’s credit risk.
In addition, the borrower would have to provide the lender with further security over and above the equity portfolio.
The number one rule of tax planning is that all transactions, when viewed on a standalone basis and as part of a larger transaction, must be on market-related terms. If this rule is followed, both of the central issues identified in respect of trusts by the Davis Tax Committee report and in this year’s budget fall down.
The number one rule of tax planning is that all transactions, when viewed on a stand-alone basis and as part of a larger transaction, must be on market-related terms