Uses of Discretionary Trusts. Presented by PJ Nel CA(SA)

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2 Uses of Discretionary Trusts Presented by PJ Nel CA(SA)

3 Trusts under attack! To curtail tax avoidance associated with trusts, government is proposing several legislative measures during 2013/14. Budget 2016: Chapter 4 Tax treatment of trusts To limit taxpayers ability to transfer wealth without being taxed, government proposes to ensure that the assets transferred through a loan to a trust are included in the estate of the founder at death, and to categorise interest-free loans to trusts as donations. Further measures to limit the use of discretionary trusts for income-splitting and other tax benefits will also be considered.

4 Trusts under attack! THE DAVIS TAX COMMITTEE SECOND INTERIM REPORT ON ESTATE DUTY In all cases where a trust deed doesn t confer upon its beneficiaries an indisputable and irrevocable vested right to both the capital and income of a trust Revenue income must be taxed in the trust in accordance with the definition of gross income contained in section 1 of the ITA. Capital income, generated while assets are held in trust on anything other than a vested basis, must be taxed within the trust up to the time of vesting or disposal as defined in paragraph 11 of the Eighth Schedule to the ITA.

5 Judge Joubert (in Brown and another v Botha and another) said there are two kinds of trusts A trust for an impersonal purpose A private trust Public, charitable, religious, etc. Discretionary trusts Non-discretionary trusts the beneficial interests appertain to the trust beneficiaries, either as income beneficiaries or as capital beneficiaries

6 The parties to a trust The founder The donor De facto the founder controls the trust. The trustee(s) De iure control of a trust is in the hands of the trustees The trust The beneficiary or beneficiaries stipulatio alteri Trust property and income The trust is set up for their benefit

7 The tax life cycle of a trust Trust is registered Letters of appointment Acquires assets Income / gains Vesting Trust revoked Registers as a taxpayer The taxes to be considered by the parties Recoupments Normal tax Capital gains Capital gains Capital gains Estate duty Transfer duty Transfer duty Donations tax Securities transfer tax Value-Added Tax Securities transfer tax

8 How does a beneficiary of a trust benefit from the trust? The founder Ascertain from the trust deed The trust The beneficiary or beneficiaries The trustee(s) The trustees have a discretion 1 Beneficiary has a vested right to assets or income 2 Beneficiary obtains a vested right to assets or income by virtue of a decision by the trustees A beneficiary - a person who has a vested or contingent interest in all or a portion of the receipts or accruals or the assets of that trust

9 Example of a clause in a discretionary trust deed Judge Maya in Abraham Krok Trust v SARS Clause 12.1 confers upon the trustees a discretion to dispose of capital of the trust in the following terms: The trustees shall have the right, if they in their sole and absolute discretion deem it necessary, to apply and utilize any portion of the capital of the trusts towards the purposes set out in 11.1, for the benefit of the child for whom the trust has been established and should they in their discretion deem fit, for the benefit of any of the other children, should circumstances in their opinion so warrant. in their sole and absolute discretion

10 Example of a clause in a discretionary trust deed Judge Maya in Abraham Krok Trust v SARS The first part of clause 11.1 provides as follows: The income of the trusts shall be applied by the trustees in such amounts and in such manner, for the benefit of the children and for their maintenance, well being, education, upbringing and reasonable pleasures, as the trustees may determine in their absolute discretion. Thus on the face of it clause 12.1, read with clause 11.1, could not be clearer: capital of the trust may be applied for the benefit of the children in the manner that the trustees may determine in their absolute discretion. in their sole and absolute discretion

11 The conduit principle Judge Stratford in Armstrong v CIR (5 April 1938) In the simple case I am now examining, namely, that of a trio comprising a company, the intervening trustee, and the beneficiary, it is manifest that in the truest sense the beneficiary derives his income from the company, for that income fluctuates with the fortunes of the company and the trustee can neither increase nor diminish it, he is a mere conduit pipe.

12 The conduit principle Judge Trollip in SIR v Rosen (24 September 1970) a principle that can be conveniently termed the conduit principle: the registered shareholder is regarded as a mere conduit-pipe for passing the dividends on to the deemed shareholder, the true recipient of them, in whose hands they consequently retain their identity and character as dividends. The function of the principle is mostly apposite to trust cases, the mere interposition of the trustee between the dividendpaying companies and the beneficiary not being regarded as sufficient to change the character of the dividends as they pass to the latter.

13 The conduit principle codified when the trust became a person From the Explanatory Memorandum on the Income Tax Bill, 1991 The present practice of Inland Revenue is In respect of such income to which the beneficiary has a vested right, the conduit principle is applied and such a beneficiary is then taxed on such income. The amendments introduced by clause 27 merely confirm the conduit principle without affecting the Commissioner's taxing rights in terms of section 7. Section 25B was introduced into the Act. The conduit principle was codified.

14 The tax consequences of income of a trust Receipt (accrual) in trust capital in nature? Settlement or other disposition No Vested rights Yes Donor Section 7 Yes Beneficiaries Section 25B No Trust 41% Distribution after tax no tax.

15 Section 7(3) - minors The founder The trustees The trust any donation, settlement or other disposition income (by reason of) has been received by or has accrued to or in favour of The beneficiaries (or) expended for the maintenance, education or benefit of (or) accumulated for the benefit of any minor child or stepchild The parent(s) of deemed to have been received by

16 Can income or a capital gain be vested and then retained in the trust? Issues to consider: These amounts would not become part of the trust capital of the trust. They are held on behalf of the beneficiaries. It is unlikely that they will fall under the mandate of the trustees. It is often argued that the obligation on the trustees to pay the money over to the beneficiaries is a loan. The questions the are: Are the trustees authorised to enter into a loan agreement. Did the beneficiaries agree to that?

17 The tax consequences of capital gains in a trust Capital gain in trust Settlement or other disposition No Asset or gain vested by discretion Yes Yes No Donor Beneficiaries Attribution rules paragraphs Paragraph 80 Trust 41% 80%

18 Example - Attribution of capital gain subject to conditional vesting Facts: (Source SARS s CGT guide Frank (35) and Furter (37) are resident beneficiaries of the Frankfurter Family Trust, a resident discretionary trust formed by their grandfather. Under the trust deed, the trustee has an unfettered discretion whether or not to vest any of the income or capital of the trust in the beneficiaries. On 1 March 2011 their father, Trevor, lent R to the trust which the trustee used to purchase listed shares on the JSE. Had the trust borrowed the funds from the bank, it would have paid interest at the annual rate of 15%. On 28 February 2014 the trustee sold the shares at a capital gain of R Of this amount he vested R in Frank, while the remaining R was retained in the trust. All dividends earned on the shares were vested in Frank and Furter. (In the current and previous years)

19 Example - Attribution of capital gain subject to conditional vesting Application of the law: There is a donation, settlement or other disposition that is subject to a stipulation or condition imposed by that person or anyone else in terms of which a capital gain or a portion of any capital gain attributable to that donation, settlement or other disposition shall not vest in the beneficiaries or some of those beneficiaries until the happening of some fixed or contingent event paragraph 70 And a capital gain that is attributable to that donation, settlement or other disposition has arisen during a year of assessment

20 Example - Attribution of capital gain subject to conditional vesting Application of the law: Total capital gain Portion of capital gain attributable to that donation, settlement or other disposition - R % 3 = R (trust held the shares for 3 years. In terms of paragraph 70 the portion of the capital gain must be taken into account in determining the aggregate capital gain (loss) of the person who made that donation, settlement or other disposition R (R45 000) Portion of capital gain vested during that year in any beneficiary who is a resident (R10 000) Portion of capital gain taxed in the trust R5 000 Note: had the full gain been vested, no amount would have been attributed to the donor.

21 Capital gain attributed to beneficiary Event a capital gain is determined in respect of the disposal of an asset by a trust in a year of assessment during which a trust beneficiary who is a resident who is a resident has a vested interest or acquires a vested interest in that capital gain but not in the asset including an interest caused by the exercise of a discretion the disposal of which gave rise to the capital gain, Subject to paragraphs 68, 69, 71 and 72, Paragraph 80(2)

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