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Changes to the Income Tax Act have important consequences for anyone who has transferred assets into trusts. Trustees and creditors of trusts need to be aware that from 1 March, anyone who has transferred assets to a trust without being paid for it may have to start charging the trust interest, or be liable for donations tax.
When someone transfers assets to a trust without receiving fair payment, they can either donate the assets and pay donations tax of 20% of the market value of the assets, or sell the assets to the trust on loan account at an interest rate the trust would have to pay any other non-connected lender, like a bank.
It has become common practice for people to sell assets to a trust rather than donate them as this meant they were not liable for donations tax, which is 20% of the value donated above R100?000 a year. Generally, no interest was charged either because the trust may not have the liquidity to repay or because whoever transferred the asset did not want to pay tax on the interest.
“Typically, the scenario would have allowed you to ‘write off’ the loan and avoid donations tax through the annual tax-exemption on trust assets of up to R100 000,” says David Thomson, Sanlam Fiduciary Services’ legal adviser.
But Sars has deemed that the practice of not charging interest on such loans is akin to a donation, says Thomson, and lenders to trusts are now required to charge interest of at least the repo rate plus 1%, or else pay donations tax.
Thomson says the new regulation typically applies to family trusts (discretionary inter vivos trusts) – where trustees have the discretion whether or not to allocate benefits from the assets or capital to beneficiaries. This does not apply to a typical testamentary or vesting trusts, where trustees are obligated to transfer certain benefits to beneficiaries.
These trusts are generally set up during the lifetime of an estate planner and hold a wide variety of assets, which could include anything from a primary residence to listed shares or even shares in a private business or insurance.
According to Thomson, the income tax element has never been the major reason behind putting assets into trusts, but many people who set up trusts may have done so to limit estate duty.
Most people, he says, move assets into a trust to protect their assets from unanticipated events like insolvency or divorce. Most would have disposed of assets to the trust on a loan account, but never charged the trust interest. “The lender would write off the loan at R100 000 per annum, and on his demise he has got no asset and has saved estate duty.”
But now, for people who have a loan account where a discretionary trust owes them money, and where they are a connected person to that trust, they need to charge interest on the loan at prime plus 1%. If they don’t do this, they will be deemed to have made a donation.
Thomson points out that you can use the R100?000 per annum to offset that deemed donation, which effectively means that for any loans under R1.25m, you effectively don’t have to charge interest.
If the trust has the liquidity to pay back interest, then that interest needs to be declared on the lender’s tax returns. The only other possible option available is to look at restructuring the trust if there is no need for it to be a discretionary trust.
Another thing to look out for, Thomson says, is that Sars has also indicated that the current interest rate of 8% will not always be the acceptable rate and that the lender must charge the rate the trust would have had to pay if the money was borrowed from a third party, like banks.
The new regulation makes setting up trusts less attractive from a tax point of view, but Thomson says tax is not the primary reason most people set up trusts. The most important reason, he says, is that it is an orderly way for people to manage their affairs and provides them with a level of comfort should they die or be incapable of managing their assets. Trusts provide peace of mind and protect assets from risk. The trust assets are not in your name, and therefore offers some protection from creditors, for example.
“Trusts are generally a vehicle to distribute your assets in an orderly fashion and have responsible and skilled people looking after them for you,” says Thomson, although there are many other reasons for setting up trusts, including charitable trusts for scientific research; bursaries for education and religious objectives, but those kind of special trusts would be exempt from the new regulations.
This article originally appeared in the xxx edition of finweek. Buy and download the magazine here.
