Estate planning: are trusts still worthwhile?

To limit tax/estate duty advantages, relevant legislature focuses on the method used to place assets into the trust, rather than on the trust itself.

Peter O’Halloran - Tax advice

Many families in South Africa have established trusts for asset protection and as a shield against high estate duty and other charges on death.

A trust, however, is a strange phenomenon. It is often thought to be akin to a private company, but of course it’s very different.

To begin with, a trust is not owned by anyone. Once a farm and financial assets have been placed into the trust, they cease to belong to the person who ceded the assets to the trust.

Moreover, the method used to place assets in the trust, rather than the trust itself, is targeted by the legislature to limit the tax/estate duty advantages of a trust.

Often the assets are donated to the trust. In this case, donation taxes might apply. If the assets are sold to the trust and the latter does not have the capital to pay, the resulting loan account will have repercussions from the point of view of tax and asset protection.

For example, the new Section 7C of the SA Income Tax Act seeks to tax loan accounts by deeming interest upon loans.

The safest method of placing an asset in a trust is for the trust to buy the asset with its own funds. The sale must take place at a reasonable value, however, or donations tax might be triggered.

But how do you create wealth in the trust in the first place? There are four ways in which to do this:

  • You can start a fresh company to operate a new endeavour. You would typically take a salary from the company, but, before it has any value, you place the shares of the company in the trust. When dividends are declared, they are received in the trust, invested and used to purchase assets or finance loans from commercial banks with which to buy assets.
  • If a trust has already bought a company and this has given rise to a loan account, the trust may obtain finance from a commercial bank to repay the loan account from the connected person, and so avoid tax.
  • You can bequeath assets to a trust in your will.
  • Life insurance held by a trust can be used to buy assets upon the demise of an estate planner.

The second or third generations of trust beneficiaries are not hard hit by anti-avoidance provisions. Also, as we’ll see in a later article, the taxes generated by the new rules (such as Section 7C) need not be especially punitive.

Advocate Peter O’Halloran is a tax specialist.