Has time run out for trustees to hide from Sars?

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The South African Revenue Service (SARS) presented a webinar on 29 July 2021 called Trust and Tax obligations, wherein they made it clear that there is a great focus on trust tax compliance. With approximately only 11% of trusts being tax compliant in South Africa, SARS will have a field day with the implementation of their nine strategic objectives, leaving trusts at great risk due to non-compliance. This may in turn lead to trustees being held personally liable by beneficiaries for not fulfilling their fiduciary obligations. Section 1 of the Income Tax Act defines a trust as “any trust fund consisting of cash or other assets which are administered and controlled by a person acting in a fiduciary capacity, where such person is appointed under a deed of trust or by agreement or under the will of a deceased person.” This definition was inserted following the decision in CIR v Friedman case of 1993, in which it was held that under common law a trust is not a “person”. A fiduciary duty is an onerous, legal obligation (a duty of loyalty and care), of a person managing property or money belonging to another person, to act in the best interests of such a person. The following strategic objectives were discussed, which trustees should take to heart and get their affairs in order (as a matter of urgency) to avoid surprise attacks from SARS, which may costs trusts – and potentially trustees – dearly, financially.

Have a handle on the trust bank account and trustee signatories

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People are often of the view that trusts do not require their own bank accounts. Trustees (and even service providers) will use any excuse to justify why separate trust bank accounts are not maintained – from being convenient to saving costs to the trust being ‘dormant’, to name but a few. Little do they realise that it is in fact, a legal requirement for each trust to have a separate bank account. The main rationale for this is to prevent any mingling of trust funds with non-trust funds, which may place the trust at financial risk.

Trustees can’t escape their fiduciary obligations

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“There is no magic in the term ‘fiduciary duty’”. This is what the judge said in the Phillips v Fieldstone Africa (Pty) Ltd case of 2004. In carrying out their duties, trustees fulfil a fiduciary position. A fiduciary duty is an onerous, legal obligation of a person managing property or money belonging to another person to act in the best interests of such a person. A fiduciary relationship arises from the nature of the actual relationship undertaken.

Making distributions to trust beneficiaries to save tax at all costs

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A trust can hold and distribute trust funds at any time, but this must be done in accordance with both the terms of the trust instrument and the purpose for which the trust was created. This may involve distributing the income of the trust among family members in a tax-effective way over many years, or providing capital from the trust at a time when it will most benefit the beneficiaries in the future, for example when purchasing a home. In practice, often trustees disregard the purpose for which the trust was set up, as reflected in its objective in the trust instrument, and blindly allocate all income and capital gains to beneficiaries (without making any payment to them) in an attempt to avoid or save tax. Little do they realise that they are slowly undoing the purpose of the trust. The tax tail should never wag the estate plan dog.

Be careful of unintentionally turning a discretionary trust into a vesting trust

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Families set up trusts to achieve the benefits of asset protection and Estate Duty minimisation. Asset protection trusts include a large spectrum of legal structures that are set up in order to mitigate the effects of divorce, attacks from creditors, and bankruptcy on the part of the beneficiary. Their main objective is the protection and maintenance of trust property for the benefit of the family members of the founder, often in perpetuity.

Can the founder of a trust be replaced?

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There seems to be a misconception regarding the position of the founder of a trust, as often we notice that a founder has already been ‘replaced’ in a trust, or we receive a request to replace the founder. The motivation for replacement stems from the death of the founder; an arbitrary person initially being named as the founder in the trust deed after the estate planner was told when they registered the trust that they could not be the founder, trustee and beneficiary; the fact that the family has lost contact with the arbitrary founder; the fact that the founder became unable to act (such as when the founder developed a mental illness such as Alzheimer’s Disease); the fact that people are getting divorced or are ending a relationship; etc.

The younger generation as estate owners and trustees

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When the founding father of Dubai – Sheikh Rashid – was asked about the future of Dubai he said: “My grandfather rode a camel, my father rode a camel, I drive a Mercedes, my son drives a Land Rover, his son will drive a Land Rover, but his son will ride a camel… As an example, Millennials (from mid 20’s to 40) in the US only controls 7% of the wealth. To put this share of control into context, at a similar age the Baby Boomers controlled 21% of the wealth. Only 11% Millennials are found to have a ‘relatively high level’ of financial literacy, whereas 28% were rated ‘very low”. This, together with the reality that the greatest wealth transfer ever of $30-trillion (R400-trillion) over the next two decades – mainly from the Baby Boomers who control 50% of the wealth for the past 20 years – will take place to the younger generations, will impact the world of wealth management, preservation (and use). The question remains – is this generation financially educated and suited to handle such a ‘gigantic’ wealth transfer?

Can you bypass Estate Duty through the use of a trust?

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Estate Duty is a material ‘death tax’ that very few people take cognisance of. Luckily, in terms of Section 4(q) of the Estate Duty Act, but subject to its strict requirements, relief is provided to surviving ‘spouses’ who may have contributed to the accumulation of their assets, by allowing a deduction of the value of all property, which accrues to the surviving spouse, from the gross estate of the deceased. No Estate Duty is therefore payable on qualifying assets. This provides some relief for surviving ‘spouses’ who may end up having to part with assets they used to share with their spouses, just to pay Sar’s tax bill. The definition of ‘spouse’ for this purpose includes a permanent life partner and not only a legal spouse in terms of the Marriage Act or the Civil Union Act. People are advised that this deduction can also be applied when a trust is set up to basically avoid/bypass Estate Duty. Such a structure is commonly referred to as a “Widow’s Trust”. Section 4(q) was however cleverly crafted by Sars and people will be ill-advised to take such advice, which may leave you ‘out-of-pocket’ upon your spouse’s death if you have not made provision for this tax. The purpose of this section is only to postpone the payment of Estate Duty and not the avoidance thereof.