Where are we with trusts and taxes after the Budget Speech?

Not that it is anything new, but ‘trust owners’ were holding their breaths yet again before this Budget Speech. It appears not to be ‘trust owners’ alone, but the wealthy in general, who are worried, as government is desperate to plug a whole in its cashflow and budget, as well as trying to create a more equal society. And it is using taxes to drive its agenda.

An interesting comment was made at a Budget Speech breakfast after the delivery of the Budget Speech. On various fronts, people just need certainty to enable them to plan their structures and finances properly. There are too many uncertainties (and threats) across various aspects impacting people’s taxes, which hinder people from making informed decisions and to stabilise their estate planning structures. As an example, since 2009, government alluded to the fact that trusts are often used to avoid paying Estate Duty. Since 2014, the Davis Tax Committee (DTC) began taking a closer look into attacking trusts through more punitive tax measures. Since July 2015 the DTC recommended removing the Conduit Principle, which is a huge benefit of a trust. In August 2016 the DTC, for the first time, recommended changes to Estate Duty/Donations Tax measures and even recommended a wealth tax. All these proposed measures, the recent major tax amendments, and the ongoing uncertainty about future measures, got the wealthy (including trust owners) wary and unable to plan properly, with reason.

With the recent attack on the wealty in the form of increased Capital Gains Tax (through a higher inclusion rate as well as a higher tax rate) and shareholder dividend taxes, the creation of a new Income Tax rate of 45% for the top tax bracket, as well as the introduction of a Donations Tax on deemed interest on interest-free loans made by individuals to trusts, government would have a hard time to convince the wealthy to pay more taxes, as they are flexible and mobile and would probably rather move their wealth offshore and pay (less) taxes elsewhere. As an illustration of the flexibility and mobility of the wealthy, it is interesting to note that despite the increase in the dividend tax rate last year, the South African Revenue Services (SARS) collected less taxes in the form of dividend taxes after the increase.

With the prime focus of SARS in this Budget Speech to collect money to make up the cash shortfall and to fund things such as free higher education, rather than to attack the wealthy in general, and which requires the least infrastructure and system changes, it targeted the “low hanging fruit” by increasing the VAT rate by 1%. It is also estimated to have the least adverse impact on the economic growth and employment over the medium term, with the biggest spenders carrying the biggest proportion of this indirect tax.

With the increase in the VAT rate impacting everybody, including the poor, SARS had to be seen to also attack the wealthy, through the increase of the Donations Tax rate and the Estate Duty rate from 20% to 25% on amounts over R 30 million. This message is clear, as it is estimated that a mere R 150 million will be generated this year from the increase in the rate. This is a small amount compared to the additonal taxes of R 36 billion that will be raised through the changes to the tax measures and the expected R 204.3 billion budget deficit, and not really assisting government to pay for its expenditure.

SARS also did not adjust the top Income Tax brackets to cater for inflation, which will make higher income earners pay R 6.8 billion more in taxes this year. South Africa has a progressive Income Tax scale, meaning that higher income earners pay a higher rate of tax compared to lower income earners. In other words, with the progressive Income Tax scales, an increase/adjustment in one’s salary (often to cater for inflation), may result in one paying Income Tax at a higher rate than before such increase/adjustment.

SARS will also get more money from the wealthy through a levy on international travel, and increased Excise Duty on luxury goods.

With the historic perception that trusts are only for the wealthy, serving as a vehicle to reduce or avoid taxes, and SARS’s scaring tactics regarding trusts since 2014, many people either moved assets out of trusts into their personal names or shied away from including trusts as part of their estate plans. This hightened focus on avoiding taxes made people forget about the core benefits of a trust, rather than saving or avoiding taxes. The prime benefits of a trust remain asset protection, protection for yourself during your lifetime (such as when you develop deseases of our modern times like Alzheimers), protection of your minor children upon your death, and the creation of continuity and liquidity upon your death.

Despite various attempts of government to remove a unique principle (the “Conduit Principle”) only applicable to trusts, which creates flexibility and a means to reduce taxes payable by a trust, to date, they have not been successful. Unlike companies or close corporations, the “Conduit Principle” allows trustees to either pay Income Tax (45%) or Capital Gains Tax (36%) in the hands of the trust, or to distribute the tax liability to the beneficiaries at their marginal rates of tax (Income Tax 18% to 45% or Capital Gains Tax 7.2% to 18%), thereby paying much less tax, whilst protecting the assets in the trust and avoiding Estate Duty thereon. You can therefore legally make use of this mechanism as part of your tax planning, and achieve better tax efficiency than you would have achieved in your personal capacity.

You can also apply the “Income/Capital Gains Splitting” principle to reduce the effective tax rate on income or capital gains generated in a trust, by distributing it between a couple of beneficiaries, to benefit from the progressive Income Tax scales decribed above.

The conclusion is that a trust, although not for everybody, is still an effective vehicle to consider as part of your estate plan. This year’s increase in the Estate Duty rate and the non-adjustment of the top brackets of the Income Tax rates (to cater for inflation), may make it worth one’s while to consider a trust as part of one’s estate plan. With the ongoing uncertainty and major changes regarding various tax measures, it is advisable to build flexibility into the structure of your estate plan, and it may be worth your while to consult a professional, who truly understands trusts and how it fits into an estate plan, to assist you. The time has also come to educate yourself, best you can, about estate planning and trusts.