Taxing the minds of trustees
Careful consideration needed of how assets will be taxed
WHEN it comes to the taxation of trusts, understanding the terms in the various acts relating to trusts can be confusing, but it’s important that all trustees are aware of how the assets held by trust will be taxed.
A founder setting out instructions for trustees in the trust deed relating to what type of assets can be held needs to be aware of how these conditions affect the trust’s beneficiaries.
Taxes relating to the trust can be attributed to the founder, the beneficiaries or the trust itself.
There are instances where the founder will set up a trust, appoint “puppet” trustees (usually a spouse, close friend or relative) and retain control of the trust by issuing instructions through the trustees.
The founder might then donate income-generating assets to the trust or divert real income to the trust while retaining control of the administration of the trust.
Setting up a trust in this manner can result in tax avoidance.
If it is discovered that the founder is avoiding tax by establishing the trust, they will be liable to pay the taxable amount in their personal capacity, as set out in section 7 of the Income Tax Act.
When income from assets held in the trust is distributed to the beneficiaries in the same tax year that it is earned, the earnings are taxed in the hands of the beneficiary instead of the trust, as stated in section 25B of the Income Tax Act.
Any income that cannot be taxed in the hands of the founder or beneficiaries is attributed to the trust and taxed at 41%.
Capital gains tax and primary residences
When it comes to capital gains tax, trusts have an 80% inclusion rate and capital gains are taxed at an effective rate of 32.8%.
The inclusion rate is the rate at which your capital gains are taxed. The effective tax rate is the average rate that the trust is taxed on the earnings of its income-generating assets.
Individuals looking to sell their primary residence, and who have made a capital gain on the property, receive a R2-million exclusion. However, property registered in a trust does not receive the same benefit.
Individual taxpayers enjoy a R40 000 capital gains exclusion annually, but a trust does not. Capital gains on a trust will be taxed from the first rand.
Special trusts
A special trust is subject to different tax conditions. One can set up a special trust under the following conditions:
When a testamentary trust is created in a will for the benefit of beneficiaries related to the deceased, the testamentary trust is taxed according to special trust rates until the youngest beneficiary is no longer considered a minor; and
Where an inter vivos (between the living) trust has been set up for a disabled beneficiary.
Special trusts have several exemptions that are outlined in the Income Tax Act.
Charitable trusts
A trust set up as a charity should be registered with the South African Revenue Service Exemption Unit as a “public benefit organisation” and must be approved under part 1 of the ninth schedule of the Income Tax Act.
Charitable trusts are exempt from paying income and capital gains tax, according to section 10.1 of the act.
Taxation of a trust can be complex due to the conditions set out in sections 25B and 7 of the Income Tax Act.
Seek out professional assistance when handling a trust’s tax as the rules must be applied correctly.
The founder will set up a trust, appoint ‘puppet’ trustees and retain control