The Purpose of a Trust

Trusts

A trust is a great vehicle if you want to protect and care for yourself and your family whilst alive.  It also facilitates leaving behind what you have – and what is needed – to who you want, the way you want, when you die. Additionally, it can save legal fees, administrative and court costs, and taxes to the maximum extent legally possible.

Trusts are formed for myriad reasons, but the most common are succession planning and provision for minors (usually done through testamentary or inter vivos trusts), and estate planning & asset protection (optimally achieved through an inter vivos trust).

When structured and managed correctly in accordance with the law, accounting principles and SARS requirements, a trust will enable you to take care of yourself, your spouse, and your family, protect and enhance your wealth, and, in some cases, reduce the amount of tax you pay.

Contrary to popular belief, trusts have limited tax advantages as they are taxed at the maximum rate of income tax and Capital Gains Tax (CGT).  There may, however, be  tax  benefits for  the founder and beneficiary of the trust, provided it is managed correctly. Tax planning may be achieved through vested and contingent/discretionary benefit  and through applying the 
condui principle. In this case, Sections 25B and 7C will come into play.

The purpose of a trust

The purpose of a trust is to hold assets and to provide for beneficiaries.  A trust comes into effect when one party agrees to make over their assets to another (the trust), for  the  benefit o the beneficiaries. This is done either during your lifetime or after death.

There are various types of trust, but the most well-known benefits of trusts (the reasons most trusts are formed) are usually related to inter vivos trusts (living trusts).  
These include:

  • Estate planning
  • Tax planning
  • Protection of assets from creditors
  • Protection against spendthrift children
  • Protection of a vulnerable spouse after your death
  • Protection of minor and/or vulnerable children
  • Income tax splitting through the conduit principle
  • Multi-ownership of assets
  • Impartiality and Confidentiality
  • Preservation of assets after death
  • Assuring rapid access to income and capital after your death
  • Cost savings as assets in Trust are not subject to the fees and costs of winding up an estate
  • Provides continuity in your affairs
  • You can measure trustees’ performance during your lifetime

Did you know?

One important aspect that is very seldom emphasised when looking at forming trusts is the incapacity of individuals. Should an individual become temporarily or permanently incapacitated (disabled), the court may appoint a curator to look after the interests of the individual. Like executors to estates, curators are remunerated for their service. But what if the curator doesn’t act in the best interest of the individual?  Should the incapacitated individual have a trust, and their assets are held in the trust, no curator is necessary to look after the financial affairs of this individual.

I have been working with trusts and trustees since 2001, and what struck me about my interactions with trustees was that many had a limited understanding of how trusts work and what their responsibilities entail.  Upon investigation, I discovered that there was very little easy-to-understand education available for them, making their already complicated job substantially more difficult. When individuals were appointed as trustees, seldom would they be educated on the roles and responsibilities they were expected to fulfil.

 Being appointed a trustee is an honour and a privilege, but it’s also a huge responsibility to ensure the trust you look after is in full accordance with legislation and common law.

The governance of a trust is completely in the hands of its’ trustees.  All assets, liabilities, rights, and duties of the trust reside in the trustees and therefore the appointment as a trustee is a position that comes with a substantial amount of responsibility.  It should therefore not be taken lightly.

Trustee Duties

When accepting an appointment as a trustee, you assume the responsibility of ensuring the proper management and administration of the trust for the benefit of the beneficiaries.

Trustee duties can be categorised into three types of duties – Fiduciary, Common Law, and Statutory Law.

Fiduciary duties

Fiduciary duties refer to the ethical duties expected of trustees. An important aspect of a trustees’ duties is its fiduciary character. A trustee is legally and morally bound to manage the trust property responsibly and productively and is under an absolute obligation to act solely for the benefit of the trust’s beneficiaries.

Common law duties

Common law duties refer to the duty and care with which trustees handle the trust and trust property.

Statutory law duties

Trustees need to familiarise themselves with the legal duties imposed on them. These legal duties are dictated by several acts, including:

  • Income Tax Act (ITA)
  • National Credit Act (NCR)
  • Tax Administration Act (TAA)
  • The Trust Property Control Act
  • Financial Intelligence Centre Act (FICA)
  • Financial Advisory and Intermediaries Services Act (FIAS)

The importance of proper trust management and administration

The importance of managing a trust goes hand-in-hand with the responsibilities of trustees. Without proper management, the trustees can land themselves in hot water with The Master of the High Court, SARS, the beneficiaries, and creditors. Poor administration may also lead to the failure of the trust.  To manage a trust efficiently and effectively:

  • Trustees are duty-bound to treat beneficiaries impartially
  • Trustees are to keep records of the trust affairs and furnish these records to beneficiaries on request
  • The trustee must always be actively involved in the administration of the trust – there is no place in our law for a passive trustee
  • Trustees must remain impartial and avoid, as far as possible, a position where their private interests conflict with their duties as trustees
  • Ensure that tax affairs of trust are up to date and handled correctly – in terms of the Income Tax Act, the trustee is a representative taxpayer and can, in certain circumstances, incur liability

Substandard trust administration by trustees

Independent trust audits conducted on trust administration indicated that:

  • A large percentage of trustees are not actively involved in the administration of the trust
  • Insufficient audit trails to maximise tax planning resulted in failing trust objectives
  • A vast majority of trustees lacked the knowledge and experience required to execute their duties as trustees
  • The absences of trustee resolutions and trustee meeting minutes resulted in contracts and trust amendments being declared invalid
  • Trust assets are unknowingly exposed to unnecessary risk, resulting in exposing the erring trustees to personal liability (often without their knowledge)

Did you know?

Substandard trust administration could result in the so-called alter ego trustAn alter ego trust, although validly created, is a trust open to trustees-beneficiaries abuse, due to a clear failure to separate control from enjoyment.

Trust Administration

Trust administration refers to the process of managing the trust affairs. This includes both the day-to-day operations and major decisions. As a trustee, you may outsource some of the functions, for example, the bookkeeping and accounting for the trust. As the trustee, however, you remain responsible for many of the trust affairs.

Three main principles governing the administration of a trust are identified by Honeré:

  1. The trustee should understand the trust deed and give effect to the deed requirements and outlines
  2. Trustees must perform their duties with care, diligence, and skill
  3. Trustees should exercise independent discretion

Even under normal circumstances, tax is a difficult thing to get your head around.  Add a trust to the mix, and the complication factor increases tenfold.

Taxation

The income of a trust may be taxable in the hands of:

  • The trust itself
  • The beneficiaries
  • Split between the trust and the beneficiaries
  • In the case of inter vivos trusts, the living founder

The decision as to who will be taxed will depend on several factors, such as the terms of the trust deed, whether or not the beneficiaries have a vested right to income, and if that income is distributed or not.  Additional factors that need to be considered are whether the beneficiaries are majors or minors, whether the beneficiaries are South African residents, and whether the trust was created within South African borders.

The identification of the person who is taxed on trust income is regulated by the provision of sections 7(2), 7(3), 7(4), 7(5), 7(6), 7(7), 7(8) and 25B of the Income Tax Act (ITA).

Calculating tax liability

Tax liability refers to the total amount of taxes owed to SARS by the taxpayer.

Two sections of the General Deductions Formula dictate how we need to calculate the taxable liability of the trust.  Section 11(a) sets out what may be deducted, while Section 23 (g) stipulates what may not be deducted.

Provisional tax

Like companies, trusts are also subject to provisional tax.  Trusts are registered as provisional taxpayers and taxed on an annual basis, with tax payable at the usual provisional tax period intervals (currently, first provisional in August, second provisional in February, with the final payment upon assessment.)

As with any other provisional taxpayer, a penalty will apply for late submission as well as an understatement of the estimated amount.

Rebates and exemptions

Unlike individuals, trusts are not entitled to primary, secondary, or tertiary rebates. They also do not qualify for the general exemption concerning local interest.

Additional points to remember

  • Trusts have a February tax year-end
  • Effective 1 March 2017, the income tax rate has been left unchanged at 45%
  • With effect from 1 March 2016, the inclusion rate of 80% (previously 66.6%) is applied to a net capital gain of a trust. This taxable capital gain in the trust is subject to tax at 45%, resulting in an effective tax rate of 36% for all capital gains.

By Renate Jute, CFP®
Noble Prosperity