It is inherent in human nature to copy what others are doing. When it comes to financial matters, however, it’s good to first understand the “whys” and “hows” before taking a leap!
Take “trusts” for instance. This is a typical example of a “Joneses” status symbol. The truth is, however, that not everyone needs a trust.
Trusts are potentially a great vehicle for minimizing estate duty and capital gains tax. Estate duty is a tax leviable on one’s property when they die. What many people are not aware of is that estate duty, which is a flat 20%, is only applicable to the dutiable net estate in excess of R3.5 million. If your estate, upon death, is not likely to reach R3.5 million, there have to be other reasons to transfer your assets into a trust, besides tax-saving considerations.
Reasons to be cautious, when it comes to trusts, include the following:
- Income tax on trusts is a flat 41%, which is the same as the maximum marginal rate paid by individuals. This makes trusts tax- inefficient from an income tax Of course, this income tax could potentially, in the long run, be offset by the savings in estate and capital gains tax.
Previously, individuals with a high tax profile would save on tax by transferring their assets to those with lower tax profiles. This loophole has largely been closed by SARS’ section 7, meant to combat such anti-tax avoidance.
2. Secondly, if assets are “donated” to a trust, the donor is levied with donations tax at a flat rate of 20%. Although SARS provides relief via a maximum tax-free donation of R100,000 per annum, this relief would need to be planned and incorporated early on in the estate plan, in order to take maximum advantage of it.
3. Although one could by-pass donations tax by “selling” the assets instead, to the trust, and creating a loan account, there is a risk that this avenue could potentially be “attacked” as a tax-avoidance scheme, particularly if the loan is interest-free. Should that be the case, the assets could be included in the estate upon the donor’s demise, rendering the whole scheme ineffective.
The need for rigorous research and consultation cannot be over-emphasised before one embarks on such a scheme.
Having emphasised the need for caution, there are great reasons to use trusts, and these include:
- Saving on estate duty and capital gains tax. This can be done by selling or donating growth-orientated assets to a trust, thus “freezing” the value of the asset to the date of transfer. This means that any growth, from the time of donation or sale, is held in the trust and not in the estate, hence will escape estate duty AND capital gains tax on the growth in value of the assets.
It is worthwhile to remember that donations tax of 20% is payable when one donates assets (except to a spouse, or if the donee falls under a list of approved beneficiaries).
- Another good reason for setting up a trust is to ensure that a business continues for the foreseeable future with minimum disruption. Such a business would be managed by the trustees, until such a time as they are convinced that the beneficiaries are capable of running the business
- A trust can also be a means of protecting the interests of minority heirs
- Additionally, a trust could also be a means of providing annuities or usufructs for surviving spouses. An annuity is a financial means of ensuring future income streams for the beneficiary. “Usufruct” refers to a situation where one confers the right to use and enjoy property, but not the right to change the state of that property. In these ways, one can provide income to a surviving spouse, whilst at the same time preserving the assets to be distributed to intended parties at a later stage.
Doing a cost-benefit analysis could save you money
This cannot be over-emphasised! The benefits of setting up a trust have already been mentioned above. The costs include:
- Professional fees – eg lawyers, accountants, tax experts, etc
- Transfer fees (ie if the property is transferred to a trust)
- Donations tax
- Capital gains tax on the transfer of an asset to the trust
- Higher-income tax rate subjected to trusts (41%)
In summary, trusts can be a great avenue for saving tax, but in order to do this properly, it is worth spending some time and money, if one is to achieve the desired results.