Summary of the meeting between the Society of Trust and Estate Practioners and Treasury:

“Treasury was most welcoming to our delegation, and we must commend them on the open and frank nature of discussions we were able to have. They offered insights into their perception of trusts and the manner in which they would like to tax them going forward. It was clear to all present, however, that Treasury certainly have not made up their mind, even at this late stage, as to what the first draft of the legislation is going to look like.
That being said, there were some areas that they are quite adamant need to, and are going to, change. The first of these is the taxation of distributions made by offshore foundations to South African tax-resident beneficiaries.

Offshore Foundations:

Treasury confirmed that all distributions made by offshore foundations would be treated as income in the hands of such beneficiaries, and hence taxed at their marginal rate of tax. This punitive regime extends even to core capital distributed from the foundation. Essentially, Treasury seems to want to disincentivise the use of offshore foundations in their entirety.

Offshore Trusts:

Interestingly though, Treasury’s representatives confirmed that the proposed punitive measures will not extend to offshore trusts. They specifically stated that it is not their intention to catch distributions made by offshore trusts in the ambit of the proposed legislation, and that they have no intention of amending the way in which distributions made by such trusts to resident beneficiaries are taxed in the foreseeable future. They, of course, caveated this statement by saying that that is not to say that they will not focus on offshore trusts in the future, they simply have no intention of doing so at this point in time. This will come as a relief to many, as the majority of queries raised by STEP members regarded the belief that the proposed treatment of foundations will also apply to offshore trusts.

We will have to wait and see what Treasury includes in their first draft of the amending legislation, but in the meantime it is advisable to avoid offshore foundations.

Resident Trusts:

If the general feeling amongst members regarding offshore trusts was that of relief, the same can unfortunately not be said of Treasury’s plans for local trusts. Treasury’s general attitude towards trusts appears to be that of suspicion, and this is evident in their imminent, unprecedented attack on the fundamental principles that underpin the taxation of trusts.

Treasury is under pressure to stamp out perceived tax avoidance that, they allege, is facilitated by the use of trust structures. Their solution to this perceived problem is to do away with the conduit principle in its entirety and tax trusts in much the same way as companies. Indeed, it was mentioned in the meeting that, in their opinion, a trust is very much like a company, and that it should therefore be taxed in a similar manner. This is clear evidence that there is a lack of understanding as to what a trust is, and what one aims to achieve in establishing a trust.

Trusts’ traditional purposes are to enable the separation of legal control of assets from the beneficiaries of trust assets – which is precisely what cannot be achieved with a company. For many of our clients, it is this legal separation of functions that ensures that assets can be held, protected and transferred between generations. The modern-day trust is also often incorporated into a person’s wider wealth management strategy as a device to manage assets over the medium to long term. Asset protection, succession planning and flexibility are thus the key reasons (which a company does not provide) for establishing and maintaining a trust structure, not tax avoidance. Unfortunately, Treasury’s view seems to be that trusts are first and foremost a means of avoiding taxes.

Over recent years, the punitive 40% tax rate imposed on trusts in respect of undistributed income means that the modern-day South African trust is far from being a tax-efficient vehicle. If one considers the additional costs of compliance in maintaining a trust structure, the argument that trusts are primarily a means of reducing costs (including taxes) incurred by the settlor/founder is ever harder to defend. Furthermore, we did mention the fact that income- and CGT splitting did not happen often due to the attribution rules contained in s7 and in the Eighth Schedule of the Income Tax Act, and that the founder/donor was taxed on such income/CGT.

Gordon Stuart comment:  This where Treasury’s attitude baffles me.  Why are they getting upset with trusts and trustees when all the trustees are doing is following the rules detailed in the Income Tax Act?  The Act clearly states that in terms of section 25B and paragraph 80(2) that if the trust distributes the income and / or capital gains to a beneficiary then the income and / or gains must be taxed in the beneficiaries’ hands and the trust must be ignored for tax.  The distribution principle is not something that was ‘invented’ by some clever tax advisor, it is SARS own rules!  I can only assume that the relevant sections were introduced by SARS and now they are getting sulky because it doesn’t suit them anymore.

Nevertheless, Treasury are not pleased with the current situation whereby trustees can choose the nature of the income being distributed to each particular beneficiary, and in the process ‘artificially’ influence the tax consequences. The example used by Treasury is the case where fully taxable income is distributed to a non-resident beneficiary, whilst tax exempt local dividends are distributed to a local beneficiary. There is undoubtedly merit to their argument, but their solution of eliminating the conduit principle altogether is comparable to using a sledgehammer to crack a nut.

Gordon Stuart comment:  Again, Treasury must understand that this ability to retain the identity of the income wasn’t something ‘created’ by the private sector.  This ability to distribute and retain the identity of the income was decided by our Appellate Division (now the Supreme Court of Appeal).  In Armstrong v CIR1938 AD 343 and confirmed in SIR v Rosen 1971 1 SA 172(A) it was the Court that held that income passing through a trust retains its identity and the trust acts merely as a conduit pipe through which the income flows.

Treasury therefore proposes that all income and gains will be taxed in the trust’s hands at the punitive trust tax rate. However, distributions to beneficiaries will be deductible up to the amount of the current year’s taxable income, and beneficiaries will be taxed on them if they give rise to deductible payments. In essence, Treasury are seeking to ‘de-nature’ the income being distributed to beneficiaries. Thankfully, one notable concession is proposed, namely that local dividends and other exempt income would remain exempt when distributed to beneficiaries. As exempt income is not included in the taxable income of the trust, it would remain exempt in the hands of the beneficiaries if distributed to them in the same year as it was earned by the trust.

Gordon Stuart comment:  Treasury are going to have to word any changes to the Act very carefully because if they don’t I foresee a challenge in line with the abovementioned two cases.

Other insights that were gleaned from the meeting with Treasury are:

The likely effective date of any changes will be 1 January 2014, although this is not certain.

Treasury will entertain the possibility of the granting of a window period to allow for persons with assets in trusts to unwind the trust in a tax neutral manner.

Treasury noted that there would not be instances of double taxation (i.e. income tax in both the trust and in the hands of the beneficiaries)”.

Gordon Stuart comment:  The timing of this is going to be very interesting with the head of legal policy, Keith Engel, and his deputy both having left Treasury.  Who is left that can draft and implement such complex changes to the Act?  And complex it will be.  The legislation is going to have to circumvent;

1. The fact that a trust is not like a company but is rather more closely related to a contract.  To quote from the minutes above – “Indeed, it was mentioned in the meeting that, in their opinion, a trust is very much like a company”.  No Treasury, it is not very much like a company!  A trust is more closely related to the law of contract.
2. The fact that the Trustees are just the Bare Dominium owners of the trust assets.  Technically the trust does not and cannot own any assets (it is just a form of contract).
3. The fact that our second highest Court has already ruled that income passing through a trust retains its identity and the trust acts merely as a conduit pipe through which the income flows.
4. As the Trustees generally have the ability to distribute income and / or capital gains at their discretion how are Treasury going to prohibit the Trustees from ante-cedently divesting themselves of the right to receive any future income for the year in favour of the beneficiaries?  It has already been held in our case law that an individual may divest himself of the right to receive certain income in the future.  If the Trustees vest the income and / or capital gains on the 1^stMarch each year then any income and / or capital gains will accrued to the beneficiaries and be taxed in their hands.  South African tax law is based on the earlier of the ‘received by’ or ‘accrued to’ basis.  If the income accrues to the beneficiaries then they become liable for the tax thereon.

Summary of the meeting between the Society of Trust and Estate Practioners (Gauteng branch) and Treasury:

Proposed tax changes:

A meeting was set up with National Treasury and the South African Revenue Services to obtain a better understanding of their intentions with regard to local trusts and offshore foundations, as well as to discuss the effect that the proposed changes may have on these entities. The meeting was attended by representatives of the Fiduciary Institute of Southern Africa (FISA), Financial Planning Institute (FPI), Law Society of South Africa, South African Institute of Charted Accountants (SAICA), South African Institute of Tax Practitioners (SAIT) and Society of Trust and Estate Practitioners (STEP).

Although there are many questions to be asked around the proposed tax changes, it is important to stress that this was just an exploratory meeting. It was clear that National Treasury did not come with any preconceived ideas, nor were they intransigent on the tax proposals. They used this meeting to gather information from the delegates and not to put forward any proposals or solutions. As they asked whether trusts are being used for tax avoidance purposes, the delegation explained all the uses of trusts, over and above the possible tax benefits. We also stressed that although a capital gain can be passed down to beneficiaries to make use of a lower rate, this is not so widely used as they thought, nor is it such a simple solution, as the asset then has to vest in the beneficiaries’ hands and loses the protection of the trust. It was further pointed out that there is also anti-avoidance legislation which can be enforced to prevent this without having to change legislation.  We also made mention of the fact that trusts are more heavily taxed than any other vehicle, and SARS has so much anti-avoidance legislation at their disposal that trusts are not tax efficient vehicles, nor are they generally advised to clients on the basis of tax saving. There was a long discussion on this point, and it will no doubt need to be addressed again.

Delegates were asked how many clients use foundations, the reasons for using a foundation, the differences with a trust, and how many clients are taking money overseas and using offshore structures. The response was that a very low percentage of clients actually set up structures offshore and that a working group can be formed to discuss offshore trusts and foundations.

There was also a lengthy discussion about interaction with the Master’s Office. Delegates proposed that the Chief Master’s Office should be approached to request trustees to disclose better and that SARS should ensure they complete annual tax returns with more detailed information.  The Master should also be in a better position to track what is going on inside trusts.  All supported the idea that tax returns and other paperwork should be tightened up to make for better disclosure.

As Estate Duty’s budgeted contribution to the fiscus in 2013/2014 is R900 million, which represents less than 0.01% of the budgeted state revenue, the delegation asked why it is not being done away with. National Treasury stressed that it is more a policy decision to keep Estate Duty than a financial one. They also advised that it is not clear why Estate Duty takings are so low. This could possibly be because of avoidance through trusts.

Overall, the meeting was perceived to be very positive. National Treasury has not finalised any tax changes and they stressed that any amendments will first be discussed in depth, put out in a discussion paper for comment, and are not likely to happen in the short term.