Is there any significance being the founder of a trust?

Often when trust practitioners set up trusts for their clients, they choose arbitrary founders for the trust, completely disregarding this critical requirement. Clients are often advised that the founder cannot, or should not, simultaneously hold the role of trustee and/or beneficiary. This is simply not true. The Trust Property Control Act acknowledges the fact that the founder can also be a trustee, through the definition of a trustee as “any person (including the founder of a trust) who acts as trustee…”.

The key element of the trust arrangement is the transfer of ownership and control of the trust assets from the founder to one or more trustees who hold the trust assets, not in their personal capacities, but for the benefit of the trust beneficiaries.

The founder is the person who sets up the trust. There may be more than one founder of a trust. This has to be the person/s who intended setting up the trust. The proposed founder of a trust should always be asked whether he/she has a true intention to create a trust for the benefit of the beneficiaries, as well as whether this person will be making the initial donation to the trust. Failure to do so could affect the potential validity of the trust. The founder may therefore not be the lawyer who sets up the trust, or his/her secretary. 

You can be founder, 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 founder of a trust may also be a trustee and/or a beneficiary of a trust. The founder is however not permitted to be the only trustee of a trust, due to the fact that a trust is a contract, and a person cannot contract with oneself. This stems from the legal principle that a trust deed executed by a founder and trustees of a trust for the benefit of others, is akin to a contract for the benefit of a third party, also known as a stipulatio alteri (Crookes v Watson case of 1956). 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 want to be the founder, a trustee and a beneficiary, then you would have to appoint an independent trustee to the trust. The independent trustee could be a person, or an entity, who has no family relation or connection, blood or otherwise, to the trustees, beneficiaries or founder of the trust, and who is also not a beneficiary of the trust.

Tax issues

It appears if so-called trust practitioners often discourage clients from acting as founders, due to a lack of understanding of the taxation laws. The anti-avoidance taxation provisions are not concerned with who formed or created the trust (the founder), but rather with the person who transferred the assets into the trust, i.e. the donor/funder. These provisions effectively seek to tax the donor/funder on the income and/or capital gain generated by those assets, if they were donated to the trust, or sold to the trust on interest-free loan or soft loan. Section 7(1) to 7(8) (for income) and Paragraph 68 to 72 of the Eighth Schedule (for capital gains), of the Income Tax Act operate on the basis whereby any income earned or capital gains made by the trust as a result of a “donation, settlement, or other disposition” (such as an interest-free loan) made by a South African resident (“the donor”/“funder”) or where the founder retains certain rights in the trust deed, will be taxed in the hands of such donor or funder. The amount apportioned to the donor/funder is the income or capital gain attributed to such “donation, settlement, or other disposition”.

These sections are therefore not concerned about who formed or created the trust, but rather with the person who transferred the assets into the trust at favourable terms. These sections effectively seek to tax the person who introduced the assets into the trust on the income and capital gains generated by those assets.

If an asset is disposed of for less than its market value, the difference between the selling price and the market value is deemed a donation for the purposes of Section 7 (Section 7(9) of the Income Tax Act). Such difference will then be applied to the provisions of the anti-avoidance rules.

It is important to note that these deeming provisions related to the donor/funder will only be applicable while such person is alive. After his/her death the trust will be taxed on the income or capital gains retained in the trust. 

Any tax payable by the donor or funder “may” however be recovered from the person entitled to the receipt (Section 91(4) of the Income Tax Act). In the event that these taxes are not recovered from the trust, it will be regarded as a donation of such amount on which Donations Tax (20%) will be payable.

Benefit of being the founder

A unique Transfer Duty concession is enjoyed by beneficiaries, who are related to the founder. No Transfer Duty is payable when fixed property is transferred to a beneficiary, who is related to the founder, by blood, within three degrees of consanguinity. This concession applies when no consideration is paid directly or indirectly by this particular relative in respect of the acquisition of such trust property (Section 9(4)(b) of the Transfer Duty Act).

Conclusion

There are ways of structuring your trust where you can be the founder, trustee and beneficiary of the trust, while satisfying the South African Revenue Service and the Master of the High Court of the legitimacy and lawfulness of your trust structure. It is critical, however, that you engage the service of an experienced professional, as the incorrect drafting of your trust deed may spell disaster.