Q: I own a farm (lifestyle, non-agricultural income-producing) in the Western Cape. The bond will be paid off in a few months. I am in my fifties with two children – one of whom is still a minor. I’d like to transfer my farm into a vehicle to preserve it for my children and their children. In the past, this would have been into a trust. However, with the recent tax changes, I’m told trusts are tax unfriendly, and I should rather transfer it into a private company. Neighbours transferred their farm to a private company, whose shares are held by a trust. However, this means paying for two bodies – trust and company. Others say I should wait and transfer it into a testamentary trust on death – but I’m not sure these are any more tax friendly than creating a trust now. Does it mean that further capital growth is in my personal estate? What’s the best vehicle in which to own a farm?
A: When it comes to the use of trusts from an estate planning perspective, there are many factors that can have an effect on one’s decision as to how to structure one’s affairs. It takes a number of meetings to iron out the best solution based on an individual’s circumstances. I would recommend that you consult with an independent financial advisor or trust specialist who can do a full fact finding and needs analysis so that they can give you comprehensive advice that is specific and tailored to your estate planning needs.
Your requirements as you describe them lend themselves to the use of a trust.
The most important aspect that one must consider is that the structure needs to separate the asset which in this case is the farm, from the entity that derives an income from it which in this case can be a business that can take several forms.
If the farm were to receive rental income from a business that rents the land for agricultural use then any liabilities of the business should not place the farm in jeopardy.
Unfortunately the South African trust environment has become less friendly from a taxation perspective, although the conduit principle still applies.
The conduit principle refers to the taxation of trusts and beneficiaries as referred to in section 25B of the Income Tax Act. The act states that “Income received by or accrued to a trust is deemed to accrue to a beneficiary who has a vested right to it.” (Source: Acts Online). This is the case only where the income is received or accrued to a trust for the “immediate or future benefit of any ascertained beneficiary”.
In short the conduit principle states that if a distribution is made to a trust and immediately distributed onwards to the beneficiaries, then the tax liability is deemed to be in the beneficiary’s personal capacity and therefore taxed at their marginal rates and not that of the trust.
From a taxation point of view a company will pay tax at 28% on its profit. If the remaining profit was to flow through to the beneficiaries as a dividend at 20% then the overall tax paid will amount to 42% of the original amount.
If a straight trust structure were to be used then according to the conduit principle, if the beneficiaries were to fall within the 40% income tax bracket (or below) then this structure would be better from a tax perspective than using a trust company structure.
The question as to whether or not you should transfer the farm into a trust in the near future rather than after your death by way of a testamentary trust depends on a few factors. The first is transfer duty. Because of the nature of the property being a farm the numbers could be quite substantial. If you were to use a testamentary trust then there would be no transfer duty. There would however still be a capital gains tax liability that can be reduced if you were to create a trust now and structure it with beneficiaries who have a lower marginal tax rate than you.
The second factor is that if you were to live for the next 35 years is there a chance that you might have a claim on your estate if you were to have a financial claim against you.
The third factor is that if the farm is transferred to the trust whilst you are alive you either have to donate it to the trust and pay 20% donations tax, or you create a loan account from the trust to yourself of the value of the farm. This loan account must by law attract interest at a commercial rate which in turn is taxable as income in your hands. (So whilst the farm has been transferred to the trust, the value remains as a loan in your personal estate). Under a testamentary trust this is not an issue.
I would conclude that a trust is probably the best vehicle in which to own the farm. This will ensure that the farm is protected for future generations to come. It is also important that whichever entity is used to derive an income from the farm, it must be kept separate from that of the trust. The idea of renting the farm for agricultural use is a good example of how the enterprise of the agricultural entity will rest separately while the trust receives income without being linked to the enterprise’s liabilities. Hence should you have no major liabilities in or linked to your personal estate a testamentary trust is probably the way to go.