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Testamentary trusts still have their place

How you can protect your assets from predators—including SARS.

Trusts have received a lot of bad press over the past few years, what with SARS taking a dim view of the use of trusts as a means of avoiding tax.

A 2008 case involving a property trust, where the beneficiaries were changed in the hope of avoiding the payment of transfer duty, is but one example of SARS’ increased vigilance when it comes to trusts.  In this particular case the loophole was closed, and the court found that transfer duty was in fact payable.

So does this mean that trusts are dead?  Not at all, provided that you use them for their proper purpose—protection of assets for beneficiaries—and not some kind of ‘tax eraser’.

A question received from one of our readers has highlighted the need for a greater understanding of the more traditional role of trust structures.  The person who sent in this question wants to put a commercial property into a testamentary trust, and is concerned about the potential transfer duty and Capital Gains Tax (CGT) consequences of such a decision.

But firstly, a quick explanation of testamentary trusts.  Known also as will trusts or trusts mortis causa, they are trust structures that come into being as a consequence of death, and the founding instrument is a clause contained in a person’s will.  Such a clause would normally direct that any assets bequeathed to a particular beneficiary are to be held in trust for a finite or indefinite period.

These trust clauses are usually encountered where the testator wishes to protect certain beneficiaries—usually minor children—who may inherit in terms of the will before they are of an age where they can exercise prudence in managing the assets inherited.  A typical clause would, for example, direct that any bequests to minor children would be held in trust until the child reaches a certain age.

However, the same degree of thought needs to go into the formation of a testamentary trust as you would do for a trust that you set up in your lifetime—especially since you will no longer be around to change your mind or clarify your intentions.  A clause giving effect to a testamentary trust should therefore identify at least the following elements:

  • The assets held. These include specific bequests in terms of the will, but can also include unspecified assets forming either a fixed percentage of the estate, or a portion remaining after all other bequests (known as the ‘residue’).
  • The beneficiaries. These are normally named in the will, or referred to by relationship (e.g. the unborn child of a person named).
  • The trustees. Someone needs to administer this trust after you are gone.
  • Distribution conditions. These include how the capital asset and/or any income is to be distributed; to whom such distributions are to be made; and under what conditions (e.g. income distributed to minor children for education purposes only).
  • Provision for termination. Many will trusts provide, for example, that the trust is to be wound up and all assets distributed to beneficiaries upon reaching a certain age.
  • Formalities. These would include the number of trustees, discretion concerning the distribution of assets and income, requirements for audit, substitution of beneficiaries, etc.

Since the formation of a testamentary trust involves the transfer of assets from a deceased estate to the trust, a number of tax consequences arise.

Firstly, there is the question of transfer duty where immovable property is concerned.  Fortunately, Section 9(1)(e)(i) of the Transfer Duty Act provides that no transfer duty is payable by an heir to immovable property transferred to them from a deceased estate, provided that they have received such property by testamentary succession.

This means that a third party who purchases a property from a deceased estate does not enjoy such exemption, and is therefore liable for the transfer duty.

However, in light of the aforementioned 2008 court case whereby the change of trust beneficiaries gives rise to a transfer duty liability, what would happen in a case where a will trust is set up for multiple beneficiaries, and one of those beneficiaries subsequently dies?  For example, the reader’s question referred to above asks what would happen if the person’s wife and two children are beneficiaries of the will trust, and the wife subsequently dies.

This situation is different to that covered in the court case referred to above.  In that particular case, the trust was effectively ‘sold’ by virtue of a whole-scale change in both trustees and beneficiaries.  A consideration was also payable, which led the court to conclude that the transaction resembled the sale of the property for a consideration, thereby rendering the transaction dutiable.

While the Transfer Duty Act does not specifically cover the situation of the death of one of the beneficiaries as in this example, it is submitted that such an event does not represent the “purchase of the property for a consideration” by the remaining beneficiaries, and would therefore not give rise to a transfer duty liability.

This brings us to the second part of the question, being that related to CGT.

When a person dies, they are deemed to have disposed of all of their assets, and a potential liability for CGT may result.  However, the property that is regarded as the deceased’s ‘primary residence’ will qualify for an exemption of the first R2 million of any gains made thereon.  The deceased would also qualify for the following CGT exemptions (according to the SARS website):

  • most ‘personal use’ assets (e.g. car, furniture, personal effects, jewellery, etc.);
  • retirement benefits;
  • payments in respect of original long-term insurance policies (which would include life cover, funeral cover, and endowment policies); and
  • an overall exemption on the first R300 000 of capital gains in the year of death (this replaces the normal R40 000 annual exclusion).

In the case of the surviving spouse (being a beneficiary of the testamentary trust), subsequently dying, the fact that she is no longer a beneficiary does not have any CGT impact on the trust, unless the trust deed stipulates that assets are to be distributed to her estate upon her death.  However, if there is no requirement to make any such distributions, her death will not give rise to any CGT liability by the trust.

If the trust disposes of an asset (whether sold out of hand and the proceeds reinvested in other assets or distributed to a beneficiary, or the asset itself is distributed to a beneficiary), such disposal will give rise to a CGT liability by the trust.  In the latter case, the capital gain is based on the difference between the market value of the asset at the time of the disposal, and its base cost.

CGT is payable by ‘special trusts’ at an effective 18% of any capital gain arising from the disposal of an asset.  There are two categories of ‘special trusts’, i.e.:

  • Special Trust Type A—a trust created solely for the benefit of a person(s) with a mental or physical ‘disability’ as defined in Section 6B(1) of the Income Tax Act; and.
  • Special Trust Type B—a trust created solely for the benefit of a person(s) who is a relative of the person who died, and who are alive on the date of death of that deceased person (including those conceived but not yet born), and the youngest of the beneficiaries is younger than 18 years on the last day of the year of assessment.

For all other trusts, the effective rate of CGT payable is 36% of any capital gain arising from the disposal of an asset.

Written by Steven Jones

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)

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