JOHANNESBURG – The recent flurry of regulatory changes and tax proposals is not an effort to reform the trust landscape per se, but rather an attempt to stop tax leakage and reduce the budget deficit, a fiduciary expert says.
On January 1, an amendment to the Estate Duty Act was introduced and as a result, over-contributions to pension funds and retirement annuities made after March 1 2015, could form part of a dutiable estate. In February, National Treasury announced a Special Voluntary Disclosure Programme to provide non-compliant taxpayers an opportunity to disclosure their offshore assets and income. The Draft Taxation Laws Amendment Bill published for public comment in July, included a proposal that aims to address the avoidance of estate duty by moving assets to a trust. And if the Davis Tax Committee’s second report on Estate Duty published in August is any indication, it might be prudent for trustees to prepare for far-reaching regulatory changes.
Nico Botha, FPSA® and CEO of ST&T Executors & Trustees (Stellentrust), says these steps are intended to curb tax leakage. Trusts are often used to reduce estate duty, and as a result it has come under scrutiny.
Reforms should also be considered against the background of efforts to reduce income inequality and the budget deficit. The majority of unemployed South Africans are relatively young, and the country could face significant problems if inequality isn’t addressed, Botha cautions.
The Davis Tax Committee has previously indicated that there is limited scope to increase personal income tax due to the relatively small taxpayer base and that the corporate income tax rate is already relatively high in comparison to other African countries. VAT seems like the obvious solution to raise tax revenue as a relatively small increase could result in significant additional tax income, but it is a politically sensitive issue that is destined to receive pushback from labour unions.
Botha says this leaves wealth taxes – in particular Estate Duty and Donations Tax. Capital Gains Tax is not considered a wealth tax, but an Income Tax on capital income.
Historically estate duty collections have been relatively insignificant and the avoidance of estate duty fairly successful as the tax system allowed for it.
Botha says South African wealth often flows into trust structures.
According to the Davis Tax Committee, only 33% of the 333 465 active registered trusts appear to be tax compliant.
Botha believes the South African Revenue Service (Sars) will examine the intention behind the creation of a trust much more closely in future. Where the structure was created for the mere purpose of reducing estate duty liability, taxpayers should brace themselves for significant scrutiny.
But this does not mean that trusts face extinction. Trusts can be a valuable financial planning vehicle, especially in cases where it is used to provide for elderly parents or children should something happen to the breadwinner.
Botha warns that if the Davis Committee’s most recent recommendations and proposals contained in the Taxation Laws Amendment Bill find their way into legislation, taxpayers with an intricate web of trust structures aimed at aggressive tax avoidance, could face a significant tax liability. And even where these structures are unbundled, taxpayers may find that untangling the web could trigger substantial Capital Gains Tax.
In light of current developments, taxpayers with trusts structures should review their entire financial and personal profile as soon as possible, he advises.
Recent court rulings have also stressed that the Master of the Court should insist on the appointment of an independent trustee when a trust is registered. To date, a husband and wife team was often nominated as the only trustees, Botha says.
Estate duty planning
For estate duty planning purposes, a common practice has been to divide assets between spouses equally in an effort to utilise the primary abatement (currently R3.5 million) fully for each spouse.
This was fairly easy to do as spouses are currently allowed to make unlimited donations to one another without incurring Donations Tax.
The Davis Tax Committee has recommended that the inter-spouse donations tax exemption should be removed. Only a reasonable cash amount necessary to sustain the taxpayer and the family up to one year will be allowed as a donation between spouses free of Donations Tax. These donations can’t be used to accumulate wealth.
Should the proposal be implemented spouses won’t be able to donate assets to one another in the current tax-free manner, Botha says.
However, there are questions about the practical administration of these one-year cash donations, as Sars is already short-staffed, he says.
Interest-free loans to trusts
The Davis Tax Committee’s proposal to curb the avoidance of estate duty by moving assets into a trust has already found its way into the Draft Taxation Laws Amendment Bill.
A common estate planning practice has been to move an individual’s assets to a trust and to finance the assets by way of an interest-free or low-interest loan to the trust. This effectively pegs the value of the assets at the date of the sale, which means that the State could lose out on estate duty, which would otherwise have been collected from the individual estate.
Botha is confident that the amendment will take effect as proposed on March 1 2017 and has advised trustees to repay loan accounts if possible and to start charging interest to limit the detrimental impact.
The Davis Tax Committee has also recommended that Sars should collect comprehensive records of usufruct and trust arrangements.
“This process should include, but not be limited to, the requirement that all holders of part interests in property be required to submit tax returns irrespective of income levels,” it said.
Botha says in his experience, Sars has requested supporting documents every time a trust tax return was submitted over the past year. Often the trust deed can provide insight into the trust’s operations.
With regard to foreign discretionary trusts, the committee also proposed that Sars should establish a separate investigations unit to thoroughly examine foreign trust arrangements.