Estate planning: Are trusts still effective?


Cape Town - As a result of recent legislative changes, the tax structures some financial planners had set up solely to assist their clients avoid or defer donations tax and estate duty might no longer be effective, cautions Sean Gaskell, ‎group managing director at the Geneva Management Group.

Section 7C of the Income Tax Act, introduced by the 2016 Taxation Laws Amendment Act, in particular, is already making the estate planning advisory work of financial planners more challenging, in his view.

Effective March 1 2017, Section 7C requires that in the absence of charging interest on loans to trusts (including foreign trusts), at a rate at least equal to the "official rate of interest", individuals will be subject to donations tax.

Previously, financial planners could advise clients to transfer their assets to a trust by way of an interest-free loan. The loan to the trust would then be written-off over their lifetimes at an amount of R100 000 per year, the threshold below which donations are exempt from donations tax.

This arrangement avoided donations tax, in addition to serving as a shield against estate duty and capital gains tax on the trust assets, upon the individual's death.

"The Davis Tax Committee took a dim view on these arrangements to avoid or defer the few taxes there are on wealth. In its review and recommendations on estate duty, the committee suggested estate duty and other taxes on inheritances are an effective mechanism to redistribute wealth and create a fairer, more equal society – more so than levying additional taxes on the incomes of the wealthy," said Gaskell.

"It can also be argued that such arrangements are unethical in a country where both income and wealth inequality are so high that they threaten the country's social and political stability and future."

The committee, however, was clear that trusts are a legitimate mechanisms for individuals to arrange their commercial affairs, but added that their use to avoid or defer estate duty is cynical.

High net-worth individuals

Section 7C, therefore, is aimed at high net-worth individuals who have set up trusts to defer estate duty, sometimes indefinitely.

Loans that trigger the application of section 7C would be those where interest alone would exceed the R100 000 per year tax-free donations threshold.

"Tax authorities hope that the current 7.75% interest rate such individuals will effectively have to charge the trust (and include in their taxable income, subject to the interest exemptions), or the donations tax they will have to pay on the deemed interest should the loans be interest free, will be enough to discourage avoidance," said Gaskell.

On a loan of R3.5m, the minimum threshold above which estate duty is levied, the taxable interest portion assuming the individual made no other donations during the year would be R271 250, equating to donations tax of R54 250.

This suggests that the potential costs may still allow for the trust option to be worthwhile.

However, on a R350 million loan, the taxable interest portion would be R27 125 000, the equivalent of R5.4m in donations tax in just one tax year.

"Tax authorities plan to close more loopholes and increase further the contribution of taxes on wealth to total tax revenues. Section 7C is just the beginning, and growing cooperation and information sharing between tax authorities in different countries will further close the opportunities to avoid property taxes on foreign assets," said Gaskell.

"Compliance, therefore, should be the message the financial planning industry should be promoting to their clients. The sooner they can dismantle elaborate mechanisms and tax shelters meant to avoid tax, the less of a headache the tax man will be."

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