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Trusts can add enormous value when structured correctly and used in the right circumstances. However, changes to legislation have made trusts less advantageous over recent years. Also, offshore restrictions for SA trusts present a conundrum for families wanting to invest directly offshore to protect against SA specific risks.

In this article, we set out what a trust is and its purpose and discuss the methods of transferring assets to a trust.  We identify its advantages and disadvantages and suggest specific scenarios where trusts are a valuable tool to be used.

What is a trust?

A trust is a structure set up by a “founder” to which assets (such as investments or property) can be housed. The assets housed in the trust are managed and looked after by qualified individuals called “trustees”. The trust will have one or more “beneficiaries” who will benefit from the income and/or capital from the assets in the trust. Examples of trust beneficiaries are family members, minor children, or charitable organisations.

The trust is formed using the founder’s wishes as guidance, which are recorded either in a document called a Trust Deed or in the founder’s Last Will and Testament.

The purpose of a trust

In practice, trusts have historically been created to reduce the value of assets that would fall into one’s personal estate on death, to ensure that beneficiaries have access to specified assets and income, and to minimise personal death taxes such as estate duty.

Examples where trusts can add value

Where assets are difficult to divide between dependants

Certain asset types such as businesses, fixed property and farming practices are difficult to divide financially between beneficiaries. Therefore, a trust can assist in an equitable distribution of income and/or capital to beneficiaries as decided by the trustees.

Assets in a trust can also be unitised to remove subjection and disputes from distribution decisions.

Where the founder wants to peg the size of their personal taxable estate

In a situation where an individual has a large personal estate that will be estate dutiable at a rate up to 25% on death, they can sell assets to a trust to limit the value of the asset in their personal estate, essentially removing the value of future growth on the assets from the estate for the calculation of estate duty and capital gains tax.

This is referred to as “pegging” or capping the value of an asset in one’s personal estate.

Where there are minor children or family members with special needs

In circumstances where family members are unqualified or unable to manage their own finances, or where beneficiaries are minor children, a special trust can be created (in life or on death through a testamentary trust) to effectively care and provide for the beneficiary/ies.

Trusts have been made less advantageous

Prior to March 2017, assets could be transferred to a trust via interest-free loan accounts. This was attractive as founders could sell assets to a trust using a loan account, and there was no cost to maintain the loan.

However, following changes to the Income Tax Act effective 1 March 2017, any loan made to a trust must charge market-related interest. This means that the trust will owe interest payments on the loan account.

As an example, an individual transfers R 10m investment to their Family Trust. The Family Trust will create a loan of R 10m to pay the individual for the investment.

The trust will have to pay market-related interest of 8.25% (R 825 000) annually on the value of the loan (using the repo rate as at March 2023). If the trust does not have income or cash to pay the interest, the donor of the investment will be viewed to have donated the interest to the trust and will be liable for additional donations tax of R 145 000 per year.

Therefore, it is no longer simple and cost effective to sell assets to a trust without incurring additional interest or donations tax implications for the trust or the donor.

Methods of transferring assets to a trust

Assets can be transferred to a trust in three ways:

By Donation

The founder of the trust can donate assets to a trust to be managed on behalf of beneficiaries. However, the value of any donation will be taxed using donations tax of 20-25% on the value of the asset.

Therefore, it is not common that a founder of a trust will donate assets directly to a trust, as this results in substantial upfront taxes being payable.

By Sale

Alternatively, a founder of a trust can sell assets to a trust at fair market value by using a loan account. This means that ownership of the asset/s will be transferred to the trust, and the trust will have a loan that is owed to the founder for the purchase price of the assets acquired.

The founder’s loan account will be considered an asset in the estate of the founder, but the loan can be paid back over time.

By Will

An individual’s Last Will and Testament (a Will) can specify assets that will be transferred to a “testamentary trust” to be managed on behalf of someone else, after death.

This is commonly used to provide for minor children or a surviving spouse who is financially reliant on the deceased.

Advantages and disadvantages of setting up a trust

Advantages

MANAGEMENT OF ASSETS Assets are managed by qualified trustees on behalf of beneficiaries.

CONTINUITY A trust does not dissolve on the death of an individual, and the trust and the assets under its control can continue through multiple generations.

TAX BENEFITS These can be created through the correct distribution of income and capital gains.

LIMITED ESTATE DUTY Estate duty tax (on death) can be minimised or capped because the growth on an asset sold to a trust is excluded from the personal estate of the trust founder.

CUSTODIANSHIP Prevents assets from being poorly managed or squandered.

ASSET PROTECTION A trust can safeguard assets from creditors.

Disadvantages

GIVING UP CONTROL Ownership and control of assets are handed over to the trustees and cannot be seen to be directly controlled by the founder or donor.

POTENTIALLY HIGHER TAX RATES Income retained in a trust is taxed at 45% and capital gains at 36%, however income and capital gains can be distributed to beneficiaries to potentially reduce tax.

ONEROUS DUTIES Trustees have onerous duties to adhere to.

COSTLY TO MAINTAIN Trusts have running costs such as the fees for an independent trustee and accounting costs for the preparation of annual financial statements and the filing of tax returns.

OFFSHORE LIMITATIONS South African trusts and entities are not permitted to invest directly offshore, unless using an Asset Swap provider which can be expensive.

 

Investonline can advise you

A financial plan has many angles that need to be considered, and important decisions are not as straightforward as one would be led to believe.

One must consider how assets and investments are structured, holistically, considering how to minimise taxes both during their lifetime and in their estate. A professionally-created financial plan will ensure the structure of your assets remains practical to provide you with sufficient accessible capital and income, while providing effectively for your loved ones or charitable organisations of your choice when you are no longer here.

At Investonline, we can assist by discussing various pros and cons of different structuring options and providing comprehensive analyses and proposals to reduce tax and manage your assets as effectively as possible.

Feel free to speak to one of our qualified Client Portfolio Managers or schedule a video meeting.