Transferring assets into an Inter Vivos Trust

by | May 25, 2018 | Advisory Services

In the 2002 decision of the Cape High Court in CSARS v Welch’s Estate (65 SATC 137), the taxpayer was found to be liable for donations tax, however this decision was reversed by majority in the Supreme Court of Appeal and raises some interesting issues relating to Inter Vivos Trusts.

The facts were as follows: Mr and Mr Welch divorced in 1996 and in terms of the consent paper concluded between them at the time, which was made an order of Court, Mr Welch recognised his legal obligations to pay maintenance for Mrs Welch and their minor child Tom, who was 14 years of age at that stage. In addition he agreed to contribute towards the costs of Tom’s education and medical, dental and related expenses. In discharging those obligations he agreed to settle certain assets upon an inter vivos trust which was to be formed for the purpose of providing the necessary income for Mrs Welch and Tom, and importantly Mrs Welch agreed to this arrangement.

Mr. Welch transferred assets to the value of R 3 200 000 to the inter vivos trust. Mr Welch died in 1996, some two months after the consent paper had been made an order of Court, and the question arose as to whether the transfer of the assets from his estate, valued as aforesaid, constituted a donation by his estate to the trust.

A “donation” is defined in Section 55 of the Income Tax Act No. 58 of 1962 as:

“Any gratuitous disposal of property including any gratuitous waiver or renunciation of a right”

The Commissioner raised an assessment on the estate of R797 940, including interest, for donations tax in respect of the transfer.

On appeal the Supreme Court of Appeal set aside the judgment of the Provincial Court, the majority of the Court finding (by a majority of three to two) that the settlement did not constitute a donation and that therefore no liability for donations tax existed.

Some of the most important factors taken into account for this majority decision was the following:

  • The test to be applied at common law to determine whether the disposition of an asset amounts to a donation, is that the disposition must have been motivated by “pure liberality” or “disinterested benevolence”; as stated in Avis v Verseput (1943 AD 331).
  • The legislature had not eliminated from the statutory definition of a donation in section 55 of the Act the element which the common law regards as essential to a donation, namely, that the disposition be motivated by pure liberality or disinterested benevolence, and not by self-interest or the expectation of a quid pro quo of some kind from whatever source it may come. And further that the word “gratuitous” as used in section 55 includes “without obligation”, “for no return”, and “without any quid pro quo being given or expected”. These meanings are co-extensive of a motive of pure liberality or disinterested benevolence.

A good example used by the majority was that, if a judge orders a large damages award to an orphaned minor to be paid to a trust to be formed is not ordering the defendant to make a donation. The defendant is not making a donation in paying the ordered damages to the trustee. It is fulfilling an obligation imposed by law on him. It is plain that by paying the sum ordered to the trustee the defendant will be discharging his obligations to the orphan. The defendant had certainly not made a donation motivated by sheer liberality nor had he gratuitously disposed of the money paid to the trustee.

Applying the above principles the majority of the Court concluded that the facts of the case were such that whatever view one takes of the definition of “donation” there had been no donation made. The primary and dominant purpose of the settlement was to enable the trustees to satisfy the legal obligations which the consent paper imposed upon Mr Welch.

The majority further found that Mr Welch had in fact received some consideration for the settlement made by him. He was under a legal obligation to pay maintenance for Mrs Welch and Tom and the Inter Vivos was created to discharge such obligation. The quid pro quo was a relinquishment by Mrs. Welch of her right to claim from Mr. Welch, as long as the trustees continued to fulfil their obligation to pay maintenance.

On a side note, this decision was also most likely used to determine the donation tax consequences of Binding Private Ruling 253 – Donations tax consequences of a transaction to introduce a BEE shareholder into a group. The decision in this ruling was also that there was no donations tax consequences. However for purposes of this article, we will not discuss this ruling.

It is important to note that this case should not be used as precedent for an estate planner to deplete his assets. The penalties for getting it wrong, namely the imposition of donations tax on the full amount settled on the trust, would be a very bad result.

The implications of Section 7(3), (4) and (5) of the Act should also be considered where there was no obligation present. If the settlement doesn’t escape donations tax as stipulated above, it would constitute a “settlement or other disposition” for purposes of Section 7. This would, of course, apply with the same force to capital gains tax considerations in terms of paragraphs 68 to 73 of the Eighth Schedule to the Act.

We would therefore advise taxpayers to consult tax and legal professionals, such as Sentinel International Advisory Services to provide them with proper advice on donations to trusts in terms of court orders.