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When and how to set up a testamentary trust

A testamentary trust is easy to set up and can have significant benefits for your loved ones.

Trust administration is a specialist and complex field of law, and it’s often difficult to know when it is appropriate to set up a trust. A testamentary trust, being the most commonly used trust in South Africa, is easy to set up and can have significant benefits for your loved ones. In this article, we take a closer look at the mechanics of a testamentary trust, what they are designed to achieve, and when it is appropriate to set one up.

The legal status of a trust

The basic structure of a trust includes a trust founder, the trust assets, the trustees, and the beneficiaries of the trust. A trust is essentially a contract between the trust founder and the trustees, the details of which are set up in the trust instrument. The trust assets are owned by the trustees in their capacity as trustees, unless the trust is set up as a bewind trust, in which instance the trust assets vest in the beneficiaries of the trust.

The rules of South African trust law are essentially a mixture of English, Roman-Dutch and South African law, with the Trust Property Control Act forming the framework on which all trusts must operate. Although a trust is not a legal entity, there are certain instances where a trust is regarded as having a separate legal identity, such as in terms of the Income Tax Act.

The purpose of a testamentary trust

A testamentary trust can be used effectively to house assets that you intend bequeathing to your minor children. Remember, in terms of our law, children under the age of 18 are not capable of inheriting which means that funds bequeathed directly to them will be administered on their behalf by the Guardian’s Fund. Any immoveable property left to minor children will be administered by the minor child’s legal guardian which may not be ideal, keeping in mind that the legal guardian may be an ex-spouse.

A testamentary trust can also be used to house assets for beneficiaries who are mentally or physically disabled and who are incapable of managing their own affairs. If you have a child who suffers from a permanent mental or physical disability, you can bequeath any assets intended for that child to your testamentary trust where your nominated trustees will administer the trust assets for the benefit of your special needs child.

Setting up a testamentary trust

In the case of a testamentary trust, the trust instrument – which is the founding document of the trust – will be your last will and testament which will make specific provision for the formation of a testamentary trust in the event of your passing. Your will must include the names and ID numbers of the trustees you have nominated, the duties and powers of the trustees, the names of the trust beneficiaries, as well as the objectives of the trust. In setting up your testamentary trust, you effectively ensure that, should you die, specific assets will become assets in the trust which must be administered for, and in the best interests of, your beneficiaries. If you intend to set up a testamentary trust in terms of your will, it is always advisable to seek professional advice. This is because, if your will is found to be invalid, no testamentary trust can be formed, and your beneficiaries may be left financially prejudiced and vulnerable.

Types of testamentary trusts

Where your trust is set up for the benefit of a special needs person who suffers from a severe mental or physical disability, you can register this kind of trust as a Special Trust Type A in terms of Section 6B (1) of the Income Tax Act which will entitle the trust to special tax benefits. To qualify as a special person in terms of Type A trust, the beneficiary must have a disability that limits their ability to function or perform daily activities, and they must have had the impairment for a period of at least 12 months. If correctly registered with Sars, this type of trust will enjoy tax rates applicable to natural persons ranging from 18% to 45%. In addition, the annual CGT exclusion of R40 000 is available to this trust, as well as the primary residence exclusion of R2 million of the capital gain on disposal for CGT purposes.

If you set up a testamentary trust to house assets for your minor children, this will be considered a Special Trust Type B, keeping in mind that the youngest beneficiary must be under the age of 18 in the event of your passing. The income tax rates for Type B trusts are the same as those applicable to natural persons ranging from 18% to 45%, although this type of trust does not enjoy the same tax benefits as Type A trusts in respect of the annual CGT exclusions and primary residence exclusions. When setting up this type of trust, you can determine at what point the trust will terminate, such as when the youngest beneficiary reaches a certain age.

Statutory and common law duties of trustees

It is important that you give careful thought to those you intending to nominate as trustees as you will effectively be entrusting them with enormous responsibility – keeping in mind that you will no longer be around when their mandate becomes effective. All trustees are bound by a set of fiduciary, common law and statutory law duties, and it is important that they fully understand what they are signing up for.

There are a number of pieces of legislation by which your trustees will be governed, including the Income Tax Act, the Trust Property Control Act, and the Tax Administration Act. Most importantly, your trustees are duty-bound to act at all times in the best interests of your beneficiaries and to treat your beneficiaries impartially. All trustees are required to actively participate in the management of the trust, to avoid conflicts of interest, and ensure that the tax affairs of the trust are kept up-to-date.

Although your trustees are able to outsource some of their functions, such as bookkeeping and accounting, they remain personally liable for the sound management of the trust’s affairs. Importantly, your trustees have a fiduciary duty which means that they will be held to a greater standard of care, equivalent to that of a company director. A crucial difference, however, is that your trustees owe their fiduciary duty to the beneficiaries, whereas company directors owe their fiduciary duty to the company and not the shareholders.

The powers of the trustees

The powers of your trustees will need to be set out in your will, with the first function being to take control of the trust assets. Where the asset is an immovable property, your trustees must ensure that the property is registered in the name of the trust and obtain the title deed for the property. Similarly, in the case of investments, they must ensure that the investments reflect in the name of the trust. Your trustees will have the power to make investments on behalf of the trust, take out insurance, provide maintenance to your minor or disabled children, and remunerate professional trustees that have been appointed, amongst other powers.

Reporting duties

Trustees are responsible for keeping accurate accounting records which must be made available to the Master if requested. Trustees also have a duty to attend to all statutory filing such as tax returns, VAT returns and PAYE. Trusts are registered as provisional taxpayers and are therefore subject to provisional tax which is usually payable as per the provision tax period intervals. Their tax year runs from March to the end of February each year. It is important to ensure that your testamentary trust is correctly classified as Type A or Type B as this will affect the manner in which it is taxed. They are also required to ensure that trustee meetings take place in accordance with the trust deed, and that accurate minutes of all meetings are kept. If the trust deed requires that the trust be audited, the trustees are responsible for ensuring that annual financial statements are timeously prepared.

Trustee liability

Because a trust is not recognised as a legal person in South Africa, it cannot be sued, although the trustees can be sued in their official capacity for any negligent or intentional wrongdoing. You cannot include a clause in your trust deed which indemnifies your trustees from liability, meaning your trustees will remain jointly and severally liable for their actions to the extent that the trust suffers damages.

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Eric Jordaan

Crue Invest (Pty) Ltd

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