With the rising demands of trust administration, reporting obligations, and associated costs,
one might wonder if trusts are still worth the effort. A trust is defined1 as “a legal institution
in which the trustee(s), subject to public supervision, holds or administers property separately from his or her own, for the benefit of another or for charitable or other purposes” for example, in the case of minors or persons with a disability.
However, in recent years, trusts have received negative attention due to their association
with tax evasion and money laundering. As a result, regulatory authorities now view them
with increased suspicion. Since 2023, the National Treasury and Financial Intelligence
Centre (FIC) implemented new laws that brought changes to international transfers and the
administration of trusts. SARS also closed in on trusts and the reporting of trust distributions, holding those responsible to task in meeting legal requirements.
Furthermore, the Constitutional Court recently delivered a landmark judgment2. The Court’s
ruling clarified the tax treatment of capital gains in multi-tiered trust structures which limits
the applicability of the ‘conduit or flowthrough principle’. SARS welcomed the Court’s
judgment, praising it for providing much-needed clarity on the interpretation of tax laws.
All these measures make it ever more difficult to safeguard the legitimate workings of trusts.
But this has been coming for many years. In the Budget Review for 2013/2014, it was put
forward that the ‘flow through’ principle of trusts must be curtailed. It was stated that,
“Discretionary Trusts should no longer act as flow-through vehicles. Taxable income and loss
(including capital gains and losses) should be fully calculated at trust level with distributions
acting as deductible payments to the extent of current taxable income.”
In basic terms, it was proposed that the income of a trust be taxed at trust level. As trusts
were taxed at 40% (at the time) and now 45%, the proposal came as quite an unpleasant
prospect.
Trusts were introduced to South Africa in the 1800s during the British colonial era. They
were primarily used for charitable purposes and later to manage and preserve assets for
wealthy families whilst offering tax protection. Over time, trusts became more widely used,
and today they are a common way for individuals and businesses to manage their assets.
However, as trusts are complex legal arrangements it may also bring disadvantages besides
being costly to set up and administer.
It is important to note that when assets are placed in a trust, the individual loses control over
them. While the trustee has a fiduciary duty to act in the best interests of the beneficiaries,
the individual will (legally) have no longer direct control in how the assets are managed.
Trusts have distinct tax implications, particularly in relation to income tax and capital gains
tax and if not set up correctly, may even give rise to estate taxes.
The (legal) nature of a trust is also not recognised in many countries around the world and
the concept of a trust is not recognised as a special vehicle for holding assets for the benefit
of others. The issue of ‘trust’ recognition is a conflict of law problem and in relation to trust
assets and the rights of beneficiaries, common law and civil law interpret ownership rights in
different ways.
South Africa and the United Kingdom operate under "common law", but most European
countries operate under "civil law", and the United States operates under a dual system of
both common and civil law. Civil law is a comprehensive, codified set of legal statutes
created by legislators whereas common law draws from legal judgments and interpretations
from judicial authorities and courts. While common law changes through judgments,
precedents and legislation, civil law is codified and only changed through legislation.
Problems arise when a civil law jurisdiction is faced with a common law trust. The common
law perspective views the trust as an entity created for beneficiaries and the preservation
and protection of their equitable rights. Under a civil law system, the beneficiary’s basic
rights may be compromised and will have to abide by the tax filing obligations in that
country.
With many South Africans having emigrated, it is critical to determine how these (now)
‘foreign beneficiaries’ will be treated in their country in which they have become tax resident,
if they were to be receiving benefits or ‘gifts’ from a S.A. trust in the form of distributions. In
the U.S. for example, beneficiaries of a foreign (non-U.S.) trust living in the U.S. are taxed on
any amounts distributed to them or deemed to be distributed to them. U.S. income, gift,
estate and generation-skipping transfer (GST) taxes have a broad reach. This can lead to
double taxation in respect of the same benefit distributed.
In short there are however still advantages for using a trust, a useful legal institution for the
protection of assets, estate planning, privacy and flexibility but the main one is continuity
whereby invaluable trust assets are preserved and passed through generations without
changing hands and the consequential taxes in S.A.
Trusts are also ideal for protecting the assets of minor children or disabled persons,
ensuring the beneficiaries are well cared for. That said, trusts should not be established
solely for tax purposes. They should be part of a comprehensive estate planning strategy.
Trusts aren't for everyone, and there is no one-size-fits-all solution. Before setting up a trust, individuals should carefully consider the advantages and disadvantages and seek
professional advice, as failure to do so could conceivably cause fiscal catastrophe.
In our next article we will unpack the recent Constitutional Court’s remarkable judgement.
BH Groenewald
Honorés South African Law of Trusts 6ed by Cameron, De Waal and Solomon
The Thistle Trust v Commissioner for the South African Revenue Service (CCT 337/22)
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