How to manage the disadvantages of trusts

Even though trusts are great vehicles to use in your estate planning, they may have disadvantages. Some of these disadvantages can be managed, and others need to be accepted. Either way, trusts are certainly not for everybody. 

The loss of legal control over assets

Your assets are transferred to the trust and are managed by the trustees for the benefit of the beneficiaries. The use of these assets is then determined by the trust deed. You no longer own the assets, but you can exercise some influence over them by being a trustee. You do not have the power to veto decisions, unless if specifically provided for in the trust deed. However, be mindful that all distributed trust income will be taxed in the hands of the donor/funder if he/she can veto distributions. A similar provision applies to capital gains distributed to beneficiaries. Remember that, for a trust to be valid, it should be the founder’s intention to have a trust in place, and the founder should transfer legal (although not beneficial) ownership of the trust assets to the trustees. Any indication that the founder retains control over the assets may result in the trust being labelled as an alter ego trust. In this case, dire Estate Duty consequences may result. 

At least one trustee should be an independent trustee. This will demonstrate to the South African Revenue Service (Sars) and creditors that the founder has properly divested of his/her assets. Although the trust’s assets are managed by the trustees on behalf of the beneficiaries, the comfort that the founder has regarding the management of the assets is that the trustees are legally bound to comply with the terms of the trust deed, and with their fiduciary duties. The trustees may only distribute assets to the beneficiaries as defined in the trust deed, and in the manner prescribed by the trust deed. They are also obliged to, at all times, act in the best interests of the beneficiaries, which may include the founder.

Estate planners can manage this disadvantage:

• Each individual’s circumstances and wishes are different. It is therefore important that you tailor your trust deed to your specific requirements. Do not accept a stock standard template that many so-called professionals make use of.
• It is permitted that the same person is the founder, a trustee and a beneficiary (Goodricke and Son (Pty) Ltd v Registrar of Deeds case of 1974), but this person is not permitted to be the only trustee and beneficiary. 
• If you are the founder of your family trust, do not allow anybody to convince you that you cannot also be a trustee (who influences decisions) and a beneficiary (who receives benefits from the trust). 
• The first trustees should be carefully selected by the founder; for example, a spouse could one day become an ex-spouse. The provision for follow-up trustees should also be well thought through by the founder and captured in the trust deed. 
• The founder is entitled to include a provision in the trust deed that enables him/her to appoint replacement trustees. This will in itself not cause a problem for Estate Duty purposes.
• The founder should ensure that the decision making provisions in the trust deed are adequately considered. The founder should be able to influence, but not control decisions made by the trustees. The founder is permitted to veto trust decisions. However, be mindful that all distributed trust income will be taxed in the hands of the donor/funder if he/she can veto distributions. A similar provision applies to capital gains distributed to beneficiaries.
• It is acceptable to insert a clause into the trust deed that requires the founder to be present at a meeting in order to constitute a quorum and to be part of a decision. This will not be problematic for Estate Duty purposes, unless the founder reserves a casting vote for himself/herself, which will enable the founder to dispose of the trust assets for his/her benefit, or for the benefit of his/her estate, shortly before his/her death. This will trigger the provisions of Section 3(3)(d) of the Estate Duty Act.

In summary, provided the founder is not seen to control the trust assets, either through his/her behaviour or through empowering provisions in the trust deed, he/she may retain some influence over the trust assets, and not lose complete control over them.

Costs

Establishing a trust generates additional administration costs and complexity in one’s affairs. It is important to demonstrate the active management of the trust as a separate entity from oneself. The costs of setting up a trust will include legal fees for drawing the trust deed and for registering the trust. Ongoing costs will include the costs to maintain a separate bank account for all the trust’s affairs. Annual financial statements must be prepared. A trust does not require an audit, unless the Master of the High Court requests it, or should the trust deed stipulate that it must be audited. Sars views a trust as a separate legal entity for which separate Income Tax returns and Provisional Income Tax returns are required to be submitted. It is now a requirement of the Master of the High Court to appoint an independent trustee for every new family business trust. Independent trustees usually charge a monthly fee for this service.

It is important that one weighs up whether the costs of establishing and managing a trust exceed any savings in terms of Estate Duty. The purpose of setting up a trust may, however, rather be the determining factor in terms of whether one registers a trust or not. It is not simply about the tax savings, which should not be the main motivation for setting up a trust in the first place. If a trust is set up to protect your assets, the benefits of a trust may far outweigh the costs of setting up and maintaining a trust. If you are sequestrated, you will lose all of your assets. Setting up and maintaining a trust may be a small price to pay when compared to losing all your assets in the event of your sequestration.

Administration

A certain amount of administrative responsibility is created and certain requirements must be adhered to when operating a trust. 

Some of these administrative burdens include:

• The compilation and retention of trust records from inception of the trust to at least five years after the trust has been deregistered.
• Trustees’ minutes and resolutions about all transactions must be drafted and retained.
• Maintenance of a separate bank account for all monies flowing in and out of the trust. It is a requirement of the Trust Property Control Act (Section 10) to have a separate bank account for the trust. 
• Maintenance of an asset register.
• Adherence to any other specific administrative requirements stipulated in the trust deed. Ensure that you understand the trust deed, together with the duties that are expected of you.

It is important to demonstrate that the trust is managed as a separate entity to the founder and its beneficiaries. If there are no resolutions, minutes, or a separate bank account, Sars and creditors, including a soon-to-be-ex-spouse, may request that the Court declares the trust your alter ego, resulting in the disregard of the trust. This “cost” may be significantly higher than the effort required to administer the trust. 

Taxation

Government has introduced all sorts of punitive tax measures to discourage people from using trusts. These punitive measures are however insignificant when compared with the potential savings in Estate Duty upon your death, as well as the benefit of protecting your assets. Although higher tax rates for trusts apply to income and capital gains retained by the trust, the trust is always the taxpayer of last resort. 

In summary, trust taxes are payable as follows:

• If a connected person made a donation or soft/interest-free loan to the trust, all income generated resulting from such a donation or gratuitous disposition will be taxed in the hands of such person until his/her death. Similar anti-avoidance provisions for Capital Gains Tax exist.
• If these anti-avoidance provisions do not apply, then the trustees may distribute income or capital gains to the beneficiaries (in the same financial year) and use the Conduit Principle to have it taxed in the hands of the beneficiaries at potentially more favourable tax rates.
• If income or capital gains are not distributed to the beneficiaries, only then will the income or capital gains be taxed in the hands of the trust.

Capital Gains Tax is payable in the trust at an effective rate of 36%, and there are no abatements, similar to that for natural persons. It is interesting to note that with the increase in the dividend tax rate from 15% to 20% for companies, the effective tax rate on an asset sold by a company and the profits being distributed to its shareholders is now more than a trust, being 36% for a trust versus 37.92% for a company (22.4% Capital Gains Tax and 20% Dividend Tax on the dividend declared). Income retained in the trust is taxed at 45%. However, the accurate application of the anti-avoidance provisions and Conduit Principle can facilitate overall tax savings instead of additional tax. Proper planning and execution must take place within a trust if any potential tax consequences are to be proactively managed. 

Consequences of trusteeship

It is important that trustees play an active and effective role in the administration of the trust. With reference to the onerous duties of trustees, a person is required to understand the personal risk involved in taking up trusteeship. The penalties for absentee or “puppet” trustees can be severe.