A closer look at business trusts

People are still advised to utilise trust structures when they structure their business affairs to avoid paying taxes. Although historically people often got away with paying minimal taxes, if that is your primary reason for establishing a trust nowadays, you are on the wrong path.

In the instance of a private trading trust, a trust is typically created by entrepreneurs whose intentions are to contribute funds towards a business, and to use the trust as the vehicle to carry on a trade (Goodricke and Son (Pty) Ltd v Registrar of Deeds case of 1974). The trustees typically have the power to trade with and develop trust assets, and the beneficiaries, who typically are issued with certificates of interest in the trust, can transfer their rights to other beneficiaries upon payment therefore. 

A trading or business trust can be structured to resemble a company or close corporation, whereby trustees can be compared to the directors of a company and beneficiaries can have the rights similar to shareholders. These trusts are inter vivos trusts – trusts created during people’s lives. They are formed to ensure the continued operation of a business that has a profit incentive. 

A trust is not regarded as an independent entity or juristic person that can be owned, sold, or transferred as would be the case with a company or a close corporation in terms of the common law, nor in terms of the Trust Property Control Act. This Act defines a trust as “an arrangement”, not as a person. A trust does not have a legal personality because it is simply an accumulation of assets and liabilities, administrated and owned by the trustees (or owned by beneficiaries in some business trusts). 

Without legal personality a trust cannot own property. Any property held in trust is held by the trustees in their capacity as trustees. Section 12 of the Trust Property Control Act requires trust property to be held separately from the trustees’ personal estates. In a business trust, the trust assets are often held by the beneficiries. These assets would therefore be included in the assets of the person (in the event of a divorce) or in the estate of such person upon his death. The asset protection provided by a trust is then lost.

As generally trustees are not allowed to expose trust assets to business risks in terms of the common law, if the assets are held by the trust, the trust deed must provide the trustees with the express power to trade with trust assets (Essack Family Trust v Soni case of 1973). This was also confirmed in the Liebenberg v MGK Bedryfsmaatskappy (Pty) Ltd case of 2003).

Without legal personality, unless a statute defines it as such (such as the Income Tax Act), a trust does not have legal standing, and the trust cannot, therefore, sue or be sued. Despite its lack of legal personality, a trust has legal capacity, and the trustees may perform juristic acts, provided the trust instrument allows this.

Even though a trust is not a legal ‘person’, a trust has an existence, separate and apart from the founder, the trustees and the beneficiaries. It should therefore achieve a separation between ownership/control and enjoyment. As stated in the Thorpe v Trittenwein case of 2007, there must not be a blurring of the separation between ownership and enjoyment and that such separation is the very core of the idea of a trust. Even the Land and Agricultural Bank of South Africa v Parker case of 2005 emphasised the requirement of the separation of ownership (or control) from the enjoyment of assets. In the Raath v Nel case of 2012 it was held that “the separateness of the trust estate must be recognised and emphasised, however inconvenient and adverse to the respondent it may be”, even though it is not a ‘person’. It is therefore important to adhere to this requirement in the appointment of the various parties (founder/s, trustee/s and beneficiary/ies) to the trust, the drafting of the trust deed and the administration of the trust.

An important consideration is that the majority of trustees should preferably be persons other than the beneficiaries, otherwise the trust may be regarded as a partnership (The Land and Agricultural Bank of South Africa v Parker case of 2005). The Court held that there is nothing wrong with using a trust for business purposes, but that there should be a separation between control and enjoyment of assets, as that is at the very core of trust law and the basis on which it has developed. Without such separation, all the elements of a partnership are often present, being a legitimate contract whereby each partner contributes money or skill, towards a common business purpose, with the aim of making a profit (Joubert v Tarry & Co case of 1915). 

In terms of business trusts, there are many cases where the parties believe that they have created a trust, whereas by law and in reality they have created something else, such as a partnership. In the Khabola v Ralitabo case of 2011, a ‘trust’ was formed to acquire agricultural land to conduct farming activities. The ‘trust’ was registered with the Master of the High Court and had a reference (IT) number. However, no beneficiaries were appointed. The Court held that no trust was formed (even if it was registered with the Master), as it is a legal requirement to appoint beneficiaries for a trust to exist. The Court found that it was rather a partnership or some other association that was formed, and not a trust.

From a tax perspective, one needs to be mindful to give trustees such wide powers in the trust deed that the South African Revenue Service can label the trust activities as speculative in nature and make it subject to Income Tax rather than Capital Gains Tax, at much higher tax rates. Section 102 of the Tax Administration Act puts the burden of proof on the taxpayer (the trust in this instance) to prove that Capital Gains Tax, rather than Income Tax is applicable.

Be mindful when you utilise a trust for business purposes – how you set it up and how you administer it.