Foreign trusts have historically been the “automatic structure” chosen to hold funds remitted offshore by South African tax residents. However, an amendment to the Income Tax Act relating to low or interest-free loans to trusts means that South African taxpayers will now, for the first time, be subjected to a tax liability on these loans.
In terms of the change, the official rate of interest (repurchase rate plus 100 basis points) has to be charged on the loan to avoid triggering tax. If interest below the official rate of interest or no interest has been charged, there will be a tax liability.
Elana Nel, senior associate in the tax advisory division of Stonehage Fleming, says the cost of maintaining trusts – both local and foreign trusts – has been rising due to heightened attention by tax authorities, compliance issues and increased reporting obligations.
She says there has been an increase in the remittance of funds from South Africa, by way of special applications to the South African Reserve Bank once the R10 million threshold has been reached. These special application funds cannot be lent to a trust and must be invested in the name of the applicant.
“This may deem the costs of establishing and maintaining a foreign trust unwarranted to house only a small portion of the taxpayer’s foreign funds remitted from South Africa.”
The official rate of interest for a loan held in South African rand is currently 7.5%, but it has been foreshadowed in the 2017 Budget Review that it could be adjusted upwards to a more “market-related” rate. Nel says this will result in an increased donation, and therefore an increased donation tax liability.
Ernest Mazansky, director at Werksmans Tax, says despite the change to the act relating to low- or interest-free loans and the additional cost, many taxpayers are reconciled to it.
He explained that the “official rate of interest” is multiplied by the loan to determine the deemed donation which triggers donations tax. This will be payable annually until the loan is repaid.
If the loan is in rand, the effective donations tax is 1.5% of the loan (7.5% of 20% donations tax rate). Usually taxpayers do not consider it too high. If the loan is in another denomination the official rate of interest might be as low as 1.5%. Mazansky, member of the South African Institute of Tax Professionals’ international tax committee, says foreign trusts remain relevant for wealthy families to protect their assets from creditors, for estate planning, and for confidentiality in relation to their financial affairs.
He acknowledges that maintaining trusts is expensive and should not be used for “smallish amounts”. His rule of thumb is that a trust becomes financially worthwhile when the foreign assets are R50 million or more.
There are other offerings, besides a foreign trust structure, such as offshore insurance products, often called “wrappers”.
“These are pure investment policies – but legitimate long-term policies nevertheless. There is typically no income to be taxed, but on death there will likely be capital gains tax and estate duty, but then the beneficiaries get the value of the policy.”
Mazansky says the asset passes to one’s heirs without the need to have a will, or without the requirement to wind up a foreign deceased estate, which would require a will in terms of the foreign country’s laws, the appointment of an executor and a delay until the heirs can receive their money.
Nel says another method of administering foreign funds is to set up a “dry trust”. The trust is only funded when the owner of the trust dies.
The taxpayer will have control over his funds during his lifetime, but will have a vehicle in which he can bequeath the assets to ensure it remains protected for the beneficiaries of the trust or his heirs once he is no longer there. She says the assets that have been taken out of the country by way of a special application – beyond the R10 million allowed for by the South African Reserve Bank – can be bequeathed to the trust on the death of the owner of the trust (settlor).
Nel says because there are no assets within the trust during the lifetime of the owner, the cost of maintaining the structure will be much less.
“While there are still various scenarios where a foreign trust may be a necessary planning vehicle, the era is over where it is advised as an automatic ultimate solution to every investor remitting funds from South Africa,” remarks Nel.