The Davis Tax Committee’s First Interim Report on Estate Duty (“DTC Report”) was released for public comment on 13 July 2015 and was met with wide debate and criticism. Although only in draft form, the report delivered some indications of potential changes to the trust tax regime in South Africa. The recommendations range from the expected to the radical and tax experts around the country waited earnestly for the 2016 budget speech to find out whether or not government would look to legislate any of the recommendations. In the budget review documents, Finance Minister Pravin Gordhan gave some indications as to what changes on the tax on trusts may be expected.
Before evaluating the expected changes, it is appropriate to recap the current tax effects of trusts relating particularly to discretionary trusts. The Income Tax Act provides for trusts to act as a conduit for tax purposes. This means that any income earned by a trust that is distributed in the same year that it is earned, is taxed in the hands of the beneficiary as if it was earned directly by the beneficiary. The trust, as a separate tax person, will be taxed on any income retained in the trust at a flat rate of 41%. The conduit principle can create tax planning opportunities where beneficiaries are earning income at lower marginal rates e.g. where beneficiaries are children with low annual earnings.
Amongst other recommendations, the Davis Tax Committee has recommended that this conduit principle effectively falls away and all income or capital gains are taxed in the trust as a separate taxpayer. To do so would indicate a departure from the way trusts are treated in almost every other country in the world. Whilst Gordhan did not confirm that this approach would be legislated later this year, he did indicate “that further measures to limit the use of discretionary trusts for income-splitting and other tax benefits will also be considered.”
Gordhan further recommended that interest-free loans to trusts be treated henceforth as donations and that assets transferred to a trust on loan account be included in the estate of the founder (or more likely the lender) on death. Typically, lenders dispose of assets to a trust on loan account which has the effect of pegging the value of the asset in their estate at disposal date and avoiding donations tax. The recommendation is now that the lender would incur estate duty on the value of the asset at death (i.e. after growth) and, if the loan is interest-free, the lender will incur donations tax at 20% on the value of the loan.
The recommendations at this stage are very cryptic. What is clear however, is that there will be some changes to the taxation on trusts later this year, it just remains to be seen exactly what the changes will be. We will have to wait for the 2016 Taxation Laws Amendment Bill (which will likely be released in July or August) to see the extent of the changes to the law. The government has identified trusts as a high priority area and so taxpayers are cautioned to assess their current trust structures for compliance so that when the tax laws are legislated, any resulting planning can be processed expediently.
Graeme Saggers, CA (SA)