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Listen: Important considerations about ‘your’ trust

‘The sad reality is for some people a trust is not the right vehicle.’ Fisa chair Ronel Williams and CEO Louis van Vuren share their insight.

 

INGÉ LAMPRECHT: The Draft Taxation Laws Amendment Bill that was released in July proposes the introduction of several measures to prevent tax avoidance through the use of trusts. National Treasury has long been of the view that some taxpayers use trusts to avoid paying estate duty and donations tax.

My name is Ingé Lamprecht and I am joined today by the chairperson of the Fiduciary Institute of Southern Africa [FISA] Ronel Williams, and the institute’s CEO, Louis van Vuren. We are going to discuss the current trust landscape and important principles of trust law.

Ronel, I’m going to start with you, because of Treasury’s view that some taxpayers use trusts to avoid estate duty and donations tax there has long been an expectation that trust legislation could see significant changes. In some circles there is even a misconception that trusts may be scrapped in their entirety. Where are we in the reform process?

RONEL WILLIAMS: Ingé, thank you for this opportunity. As you’ve mentioned, in the last couple of years there’s been a renewed focus on trusts and it’s very clear that Treasury is looking at trusts and the way they are operating, etc, and also the tax implications.

So what we have in a nutshell is in last year’s 2015 Budget Speech there was reference made to trusts, that was not the first time, but this is now when we are starting to see some more focus.

And then I think very importantly last year we had the first interim report of the Davis Tax Committee that deals with estate duty specifically, but trusts obviously form a big part of estate-duty planning. So there was quite some focus on that and there were some proposals made. The industry had an opportunity to give feedback, which was done by the end of September in 2015. Unfortunately almost a year later we are still waiting to see what is going to come from those comments and proposals that were put through back to the Davis Tax Committee.

The next one then is in the 2016 Budget Speech there was again reference made to trusts. This time slightly more specifically it talked about loan accounts for the trust and we are probably going to discuss that a little further, but it just really relates to when somebody places assets in a trust and he does so by way of a loan account. In other words, he sells it to the trust but the trust doesn’t pay him immediately; the trust owes him that money. There are certain income tax implications already, but Treasury indicated that they also want to look at those loan accounts in the context of estate duty and how it relates to that. So what we have at the moment, the Draft Taxation Laws Amendment Bill, was issued in mid-July, and there actually are proposals in the document relating specifically to the loan accounts and the charging or not of interest on that.

INGÉ LAMPRECHT: Louis, against this background do you believe it would still make sense for South Africans to set up or use a trust?

LOUIS VAN VUREN: Yes, Ingé. From FISA’s side we have for a long time advocated the view that trusts should not be primarily used for tax avoidance. A trust is not the way to go if you want to save tax, and over the last 20 years several measures have been put in place to prevent large-scale tax avoidance through trusts.

However, trusts from our point of view have a very important role mainly in asset protection, because incidentally, if you think about what a trusts happens to be, a trust is the handing over of assets to a trustee to hold, manage and grow those assets for the benefit of the beneficiaries of that trust.

So situations where trusts can still be used are the so-called testamentary trusts where the trust is set up in the will of the original owner of those assets to be managed for minor heirs or for heirs in general, to protect the assets against financially illiterate or gullible people or people who are otherwise not in a position to manage those assets properly. Then of course the protection of minors and other vulnerable people can also be done through what is colloquially known in South Africa as a family trust, which is basically an agreement between the previous owner of the assets and the trustees to manage the assets in trust for the benefit of whoever the beneficiaries may be. But a good way to use it is to make provision for people who are not in a position to manage those assets themselves.

INGÉ LAMPRECHT: Ronel, Louis just referred to some of the trust structures out there. Can you briefly sketch the landscape? What do the different type of trust structures entail?

RONEL WILLIAMS: Ingé, as you say, Louis has given us the brief background or the understanding, so the main difference is the source of where the trust originated from – and that’s what Louis referred to. So a person can draft a will and in terms of his will he can provide that assets after his death will go into a trust. That is the so-called testamentary or will trust and all it means is that the trust will only come into operation when that person dies.

The other main area that we look at is where somebody during his lifetime, while he is alive, sets up a trust. That’s what we call the inter vivos – which is Latin for “during life” – trust, and that is the one that Louis said is an agreement, because in that one the founder of the trust and the trustees enter into an agreement in terms of which they set out how the trust will be run, etc, who the beneficiaries are – whereas in the will that’s a unilateral act, so it is just the founder himself who sets out the terms of the trust, etc.

Then once we start looking at trusts – and it gets quite technical – there also then is the way in which the assets and/or the benefits of the trust will be dealt with. And then, just very broadly speaking, we talk of a discretionary trust or a vested trust.

A discretionary trust really is just where the trustees have the discretion to decide how they deal with the income, how much, if anything, they give to the beneficiaries. That also relates to the assets, the actual capital of the trust. And in a vested trust what it really means is that beneficiaries actually are entitled to benefits from the trust.

The distinction becomes quite important specifically in the so-called inter vivos trust, because it has certain tax implications when you have to know whether a beneficiary is entitled to income or whether the trustees will decide whether or not they get an income. It gets very technical and this is just a very broad overview.

INGÉ LAMPRECHT: Louis, I’d like to move on to some of the principles of trust law. One of these principles is that trustees must act jointly when making decisions unless the trust instrument specifies otherwise. Trust deeds often provide that decisions may be made by a majority vote and people regularly assume that this means if there are three trustees and two of them decide something, the decision is valid. Is that the case?

LOUIS VAN VUREN: It can be the case, depending on what the trust deed specifies. But an important mistake that we find that many individuals make who are involved with trusts is that they think if there are three trustees and the trust deed makes provision for a majority vote, that they only need to get two of the three together and take a decision.

That was a very costly error in a case a couple of years ago in the Free State, a High Court decision where the original owner of the assets, who was also the founder of the trust, and the accountant, who were two out of three trustees of the trust, decided to institute legal action against a company that owed them some money. The third trustee was the founder’s daughter, and she was never even involved in the decision. She was not even aware of the meeting where the decision was taken, and the upshot of that was that the Free State High Court said to the trustees: “I cannot hear your case because you are not properly before me because you didn’t follow the rules. You did not involve all three trustees in the decision.”

All that a majority provision in a trust deed really means is that once all the trustees have been invited to a trustee meeting, whatever decision they take there by a majority will hold sway and the minority will have to fall in with the majority. But it does not mean that you can ignore one or two or more of the trustees as long as they are in the minority, and not even invite them to the meeting where the decision is taken.

INGÉ LAMPRECHT: This principle could have serious consequences when the decision relates to immovable property. Can you explain why that is the case, Ronel?

RONEL WILLIAMS: Yes. In South Africa we have the Alienation of Land Act, and that determines that any alienation – which we normally know as a sale – of land must be in a written document and signed by all the relevant parties, otherwise it will not be of any force or effect.

Now, when you and I transact and I sell my property to you, it means that both you and I have to sign that written sale agreement, because that sets out the terms of the agreement. When you deal with a trust, you would more than likely have more than one trustee and what it means – and it also relates back to Louis’s discussion preceding this – is that all the trustees should sign that agreement. But from a practical point of view it often is decided that one of the trustees will represent the trust and sign the documents on behalf of all the trustees. Now that decision first of all by the trustees to sell the property and to accept the terms of the agreement, and then to authorise one of the trustees to sign the agreement, that decision has to be taken before that agreement is signed. It has to also be in writing.

So the practical thing is – and that’s what we see quite often – is a deed of sale is signed by one of the trustees, and let’s assume that it’s the trust that’s selling the property, the one trustee signs and then sends it to the other trustees, saying “have a look at this” or informs that it’s happened. And because of the Alienation of Land Act that says if this was not done, if that resolution authorising that trustee was not signed before the agreement was signed, that transaction is actually a void, which means that transaction falls through. And with the sale of land you quite often have significant penalties. There is always a provision for breach of the duties of the parties. So if it is that one party – being the trustees on behalf of the trust – have now breached what they are supposed to do, there could be serious financial consequences for the trust flowing out of that.

INGÉ LAMPRECHT: What is seen in practice, Louis?

LOUIS VAN VUREN: In case law in South Africa there is a well-known case where the previous owner of the assets, the founder of the trust, bought a piece of land without getting prior authority from his co-trustees, in writing as required by the Alienation of Land Act, and signed the deed of sale with the seller of the land. When the seller of the land realised that he made a mistake because there were township developments going on in the area and the land became much more valuable, he was obviously looking for a reason for the contract to be invalid. Because the rules had not been followed by the founder of the trust and his co-trustees, the seller of the land had the excuse he needed to have the contract declared void. This case went all the way to the Supreme Court of Appeal with tremendous cost to the founder and “his” trust.

And then a case that I was involved with myself, where I was the professional trustee and one out of three trustees – the founder of the trust went ahead and sold a piece of land without even involving any of his two co-trustees, myself included. In that case the contract was also then declared void.

INGÉ LAMPRECHT: Another essential requirement for a valid trust is that the founder effectively transfers ownership of the asset and hands over control of the assets to the trustees of the trust. While the transfer of ownership usually takes place, in practice it often happens that the founder still continues to treat the assets as his own. So even if I was the founder of a trust and I originally transferred the assets to the trust, it’s not a case of “my” money or “my” affairs. Ronel. Is that how it works?

RONEL WILLIAMS: Yes, Ingé, that’s a very important point and unfortunately quite often missed. As you rightly say, that’s one of the essential requirements. Any person who wants to set up a trust as the founder, must know that once that trust is set up the trust becomes a completely separate entity from that person. Trusts are viewed separately, they are taxed separately, and the founder, once he hands over the assets to the trustees – and keep in mind he could be one of the trustees – must now understand that these are the assets of the trust, and the trustees are now empowered and authorised to act on behalf of the trust. They make the decisions. He cannot tell them what to decide, he cannot tell them how they must deal with things.

Although we keep saying this to clients and clients quite often say to us, “Yes, yes, I understand,” then in the same conversation later they again talk about “my trust” and you are also referred to “my trust” or “my money” or “my affairs”. I have sat with clients and explained to them that it is no longer theirs and they’ve said, “Yes, I know, but I put the money in there. It is my money that went in.”

I think that’s an important starting point. Whenever a client says I want to set up a trust, the consultant dealing with him must understand and must ask the right questions and get an understanding of how the client is going to view that going forward, because the sad reality is that for some people a trust is not the right vehicle. And any client who has an issue with the fact that he loses control, and the control and the ownership is now going to sit with the trustees, really should think twice before setting up a trust because we’ve spoken about this before – there could be consequences in law if a person continues to handle and deal with those assets as if they are his and they actually now sit with the trustees in the trust.

INGÉ LAMPRECHT: Louis, in practice what do you see in this area?

LOUIS VAN VUREN: There’s a long list of cases in our courts, especially in divorce matters, where the courts have labelled these trusts, where the founder continues to control everything and really does not relinquish control over the assets, where the courts have labelled these trusts so-called “alter ego” trusts, meaning basically that the original owner of the assets who usually happens to be the founder of the trust, regards the trust as his alter ego.

And in divorce matters the courts have consistently, where those circumstances prevail, looked through the trust and taken the value of the trust assets into consideration for a fair division of assets upon divorce under Section 7 of the Divorce Act. So, although the courts did not say, “Take the assets out of the trust,” the value of those assets was taken into consideration in determining what a fair division on divorce would be.

INGÉ LAMPRECHT: That was the CEO of the Fiduciary Institute of Southern Africa, Louis van Vuren, and the chairperson, Ronel Williams.

* This content was sponsored by the Fiduciary Institute of Southern Africa.

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Ah – the plot thickens. I administer a family trust. I have (with the consent of all trustees) set up what I call “loan accounts” for the beneficiaries, of which there are six. But none of these beneficiaries have actually sold any assets and loaned the cash to the trust. Nor have they made any donations to the trust. The “loan” accounts are there to maintain the conduit principle (retaining its nature) in respect of distributed income. Chiefly dividends, which have been taxed already (DWT) and these are kept within the trust. But a fair amount of interest as well as occasional capital gains (or losses in some instances). These are distributed to the beneficiaries’ “loan” accounts. The trust is discretionary and the beneficiaries are not entitled to demand any pay-out. From the article above, I am beginning to wonder if these “loan” accounts are actually loan accounts at all. Nobody lent anything to anyone else – its just a convenient way of doing the bookkeeping. Can I simply change the names of the accounts into something like “due but not payable” to (beneficiary name). @Carmen, can you comment? I always value your views and advice.

Yes, there are cases where everything is done just by what you call bookkeeping. Those are the cases where the original owner of the assets never made the mind shift that the assets no longer belong to him (mostly men) and effectively treats the trust assets as his own and calls the shots. However, those are also the cases where the courts “look through” the trust when it comes to divorce. It also opens up the possibility that the minor children beneficiaries, when they grow up, can start holding dad responsible for his shenanigans and the fact that he did not fulfill his fiduciary duty as a trustee properly. In my view, if you cannot make the mind shift and realise that you are no longer the owner of the assets, but the trustees as joint co-owners now own the assets for the benefit of the beneficiaries, STAY AWAY from trusts. Trusts are great for asset protection if handled correctly, but are going to bite a lot of cowboys who cannot make that mind shift.

@Phil99

Ah, so that’s what you meant by loan accounts the other day. You don’t say why the distributions aren’t paid out (accumulated on behalf of minors ?) but I assume they are reflected as such in the beneficiaries’ tax returns. It’s their money, not the trust’s, and the trustees’ discretion has been exercised in getting to that point. I would be less than charmed at paying tax on income I have no right to have paid to me ! They have to be paid at some point, you could describe them as distributions payable.

Perhaps you’re trying to have your cake and eat it ?

@Phil99

The plot thickens indeed ! So these are the loans you were referring to in the other post ? I tried replying earlier but I don’t think the post ‘stuck’, so I’ll try again.

The trust is discretionary ; the trustees decide to distribute certain income and gains, which is the logical thing to do to avoid income tax liability in the trust as such, and they decide to credit specific beneficiaries. Decision made. And the decision has legal consequences, for example the distribution is taxable in the hands of those beneficiaries, whether it’s paid out or not (you don’t say why it isn’t paid out, I assume it’s accumulated for the benefit of minors ?) And the amount distributed now belongs to the beneficiaries, not to the trust. At some point, the beneficiaries must have a right to be paid out. If one of the beneficiaries dies, the amounting standing to his/her credit in the trust is an asset in his/her deceased estate, it isn’t just reversed into the trust capital again, not so ?

So they are loans, in the sense of debts. I don’t think it matters whether you call them loan accounts or distributions payable. I don’t think the fact that they are unpaid will have any tax consequences as long as the distributed income is declared appropriately. The tax issue is about the specific loan account arising on the initial sale of assets into the trust (if indeed there is one in your case).

I hope that helps. The only thing I find strange is your statement (in the other post) that the loan accounts don’t ‘vest’ in the beneficiaries – they must do eventually.

Similar in some ways to the trust that I administer.

Seems like more a current current liability account in the trust than a loan account?

Problem in the future is that the collaborators are planning to discontinue the conduit/ pass through principle and remaining income in the trust will be taxed at 41%

Actually ‘inter vivos’ does not mean ‘during life’ and is better translated as ‘between living people’.

But an interesting and informative discussion, it’s not all about tax.

“inter vivos” can have either meaning, depending on the circumstances of use. If the action occurs between living people, and is such that both sides are not equal, then it becomes “intra vivos”. Minor picky point, but I recall many discussions about this, all of which were academic and achieved absolutely SFA other than to waste time! :-))

I don’t buy “intra vivos” at all, @Phil99 ! But if you direct me to an authoritative example….

Agreed cheetah58. In my experience it is absolutely scary how little people actually know about the legalities of running a trust. I think if people actually knew how many trusts are collapsed by the courts either because the trust wasn’t administered correctly or because they are deemed alter ego’s, they might not be so eager to form them in the first place.

End of comments.

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