Proposed regulatory changes affecting the trust landscape and suggestions that these entities could face much closer scrutiny will likely see a significant reduction in trust numbers.
Hugo van Zyl, chartered accountant and master tax practitioner at Breytenbachs Cross Border Advisory, says there is a real risk that the number of trusts will drop considerably. This is not only the case for so-called active trusts but also for smaller trusts holding a single (for family use only) property, which may be regarded as inactive.
While one tax commentator at the recent 2016 Tax Indaba, suggested that up to half of trusts might disappear as a result of clean-up efforts, Hanneke Farrand, director in ENSafrica’s tax department, says she does not necessarily agree with this view.
Farrand says regulatory changes will improve compliance and create an awareness to keep proper records and pay attention to trust administration.
Trusts with a real commercial purpose will remain intact, even if it comes at a higher tax cost, she says.
However, taxpayers with low value trusts that serve no real commercial purpose “should probably get rid of it”.
Of particular interest, is a Section 7C proposal that aims to curb the avoidance of estate duty and donations tax when someone sells assets to a trust and finances the sale through an interest-free or low-interest loan.
The Davis Tax Committee’s Second Interim Report on Estate Duty also suggests that trusts will likely face meaningful scrutiny going forward. Only 33% of the 333 465 actively registered trusts appear to be tax compliant.
Van Zyl says the majority of his clients typically only hold a second property or holiday home in a trust, particularly where the trust asset is used by siblings or a group of related people and funded through loan accounts. In this case the trust was not created to avoid estate duty, it is merely the most suitable legal entity for the property users. Using a company may have forced a share block company register onto the family or closely related group of people.
For some clients, the best way to deal with the proposal will be to sell the property as the trust has no physical cash to repay the loan. After the sale of the property, the trust will dissolve.
In some instances it may be more advantageous to move the property and the linked mortgage or loan to a company 100%-owned by the trust, he says.
But the Income Tax Act rules as well as the Companies Act rules dealing with such a section 42 arrangement are complex, expensive and have unintended consequences such a share block rules, fringe benefit rules and dividend withholding taxes.
Good or bad?
Although a reduction in trust numbers may simplify Sars’s enforcement efforts, the 7C proposal has been widely criticised with some arguing that it may be discriminatory on a religious basis.
Moreover, there will be instances where there is not enough liquidity in the trust to settle the tax obligation. It will become very punitive if the trustees are forced to dispose of assets purely for purposes of dealing with the tax liability, Farrand says.
“I think it is really bad. I really think that Section 7C is a little bit immoral,” Van Zyl says.
The proposal does not take existing tax laws into account, and as a result it may trigger two different deeming provisions simultaneously, he argues.
“Which one is going to apply? So there is a conflict.”
Van Zyl says there could indeed be litigation from bigger families and substantial trusts that may take the issue to the Constitutional Court.
Clients of bigger trust companies and corporate trustees may well run into significant problems as trust structures may be too complex to untangle.
Van Zyl says the current proposals aim to plug perceived holes in the tax system, but does not consider the system holistically.
Generally speaking, there are too many proposed legislative changes at the moment, Farrand adds.
One way of addressing existing issues may be to conduct both a validity audit into trusts with the Master’s Office and ensure full tax compliance, before attempting to amend tax law only, Van Zyl says.
The Davis Tax Committee has indicated that despite Sars’s modernisation and reconstruction over the past 15 years, “enforcement measures to contain the use of trusts have received little attention”.
“At the very least, there should be strict enforcement measures in place to ensure that all income of trusts is ultimately subjected to tax at some point,” it said.
But despite the changing landscape, trusts remain a necessity, Van Zyl says.
In some instances, company laws are too complex to cater for situations where property must be secured in a legal structure. For most professional persons, trusts are also necessary for creditor and family protection.
Where a man has children with two spouses and has to look after both families, trusts are also useful to ring-fence the assets per marriage, Van Zyl says.
“There is really a big need for trusts. Yes, the future application will be very restricted, but I think there is a continued need for trusts.”
Farrand says even in the current regulatory environment trusts still have a future.
“There are a whole host of reasons why you would have a trust other than just for the tax ,” she says.
Examples include succession planning, the housing of complex assets such as farms, shares or family businesses, legacy properties, educational trusts or to provide for minors.