As mentioned in our Newsflash which followed on the Budget Speech of our Finance Minister for this 2016 Tax Year, the Government was planning to ‘turn its guns’ onto Trusts. To cut a long story short the Government was plainly of the view (with some justification) that Trusts were being used to unfairly reduce Income Tax and Estate Duty (death tax) burdens on taxpayers.
The first salvo has been presented to us in draft legislation intended to become law as of 1st March 2017. This first salvo addresses the matter of loans made to Trusts by “connected” entities. In this regard and by way of a very simple example, if I were to establish a Trust for myself today, it will be a very impoverished Trust. Although like any newborn, it will exist, it will (save for something very nominal) have no wealth at all. If it accordingly wishes to say, buy a house, it would have to borrow money and the most obvious person to ask for such loan would be me. If I agree to lend it the money it would owe that money to me until it is repaid. I would be said to have a loan account in the books of account of the Trust. For reasons that are fairly obvious, such loans do not normally stipulate for interest to be payable. It would, after all, be somewhat silly for me to burden my own Trust with an interest bill. It would effectively amount to me charging myself interest! The new Tax Law proposed by SARS stipulates that even though I might not wish to charge my Trust interest, interest is deemed to accrue on such loans (existing ones and future ones) at a market-related rate. I will, in other words, be obliged to declare such income in my personal tax return and pay tax on it! To add insult to injury, the law requires my Trust to actually pay that interest to me within a period of three years of the interest accruing, failing which the law will assume that I have donated that interest to the Trust and Donations Tax of 20% will be levied!
The genesis of the abovementioned amendment to the Tax Laws is to be found in the recommendations of a Commission of Enquiry which is currently being conducted at the instance of our Government under the stewardship of Judge D Davis. That Commission was asked to review all Tax Laws and make recommendations to the Government. Sadly for those of us who are heavily committed and invested in Trusts or those of us who have fairly significant financial means, Judge Davis has not, by any means, finished looking at Tax Laws and has made a whole host of other suggestions to the Government. Whether they will all become law is of course debatable but bearing in mind our Government’s determination to close the gap between the ‘haves’ and the ‘have nots’, I am personally of the view that all of the recommendations will be implemented in one way or another and probably as aggressively as possible.
Herewith then a view of Judge Davis’ further thoughts (in no particular order):
- Estate Duty – As the law now stands if I die, Estate Duty (death tax) is payable at the rate of 20% on the value of my estate over and above R3.5 Million. It is proposed that :
- Nominating one’s spouse as beneficiary of one’s estate will no longer postpone the implementation of the Estate Duty. In this regard and in terms of the law as it stands, the implementation of Estate Duty is postponed until my spouse’s death in respect of anything which I leave to my spouse in my Will. In other words if I die today and if my estate is worth more than R3.5 Million, Estate Duty will be payable by my Executor. If on the other hand I left my estate to my spouse, the Estate Duty will not be payable now. It will only become payable when my spouse dies. The idea behind the current law is to ensure that me passing away does not affect the standard of living of the spouse who survives me.
- The threshold for Estate Duty should be raised from R3.5 Million to R15 Million. That would seem to put Estate Duty issues beyond the concerns of most people but I am personally of the view that our Government will seize the idea of reviewing the threshold, but set it much lower!
- Estate Duty will be raised from 20% to 25% for estates having a value in excess of R30 Million. This amendment also seems to put the issue of Estate Duty beyond the concerns of most people but I am personally of the view that our Government will seize the idea of reviewing the percentage but set the threshold much lower! It should be noted that if Estate Duty increases Donations Tax will increase by the same amount as the two taxes are always the same.
- Donations Tax – As the law now stands and barring a certain nominal permitted amounts, any donation made by a taxpayer is subject to Donations Tax of 20%. This does not however apply to donations between spouses which are permitted without any tax consequence. Judge Davis proposes that this privilege will be removed and that save for a few fairly insignificant exceptions, this privilege will be ended and donations between spouses will be subjected to Donations Tax. As already intimated under the topic of Estate Duty, I predict that Estate Duty will be raised and that Donations Tax will accordingly be likewise raised.
- Capital Gains Tax – As the law now stands if I die I am deemed to have sold all my assets for their market value and if that results in me having made a deemed capital gain (profit), Capital Gains Tax will apply to that profit. In very similar fashion to Estate Duty the implementation of this tax is currently postponed to the date of the death of my spouse in respect of assets which I leave to my spouse. Judge Davis proposes that this postponement of tax be removed but that the threshold for payment of this tax be raised from R300 000 to R1 Million.
- Trusts – Judge Davis has recommended to the Government that the ‘first salvo’ against Trusts dealing with interest on loan accounts should be broadened and that if no interest is charged on such loans, all the assets of my Trust should be deemed to belong to me at the time of my death and be exposed to Estate Duty. In other words that the Government be entitled to effectively ignore the existence of the Trust completely. In addition to this Judge Davis has recommended that the ‘flow-through principle’ should be blocked and only allowed in very limited circumstances. In this regard and as the law stands, Trustees can decide to pass on to Beneficiaries of the Trust, pre-tax income where the tax will then be payable by the Beneficiaries. This is done quite regularly to benefit from the difference between individual and Trust tax rates.
From the above it seems fairly obvious to me that Judge Davis and his Commission have finally decided that one of the best ways to “redistribute wealth” and to “undo the injustices of the past” is to tax the wealthy when they die. After all the dead don’t complain!
If I already have a Trust and have over the years and in accordance with the law as it currently stands accumulated all the wealth in my Trust which would otherwise have been mine and thereby built up a significant loan account, what can I do to avoid the attack on Trusts which Judge Davis has initiated? If I do nothing, there are going to be changes which will make it very expensive for me and possibly enable the Government to look right through my Trust and deem all my Trust’s assets to be mine and to be subject to the higher rates of Estate Duty which I have predicted. The answer lies in a donation. In other words, what I should do (as expensive as it might be) is donate my entire loan account to my Trust (in other words release my Trust from that debt) immediately and pay the Donations Tax at the current rate of 20%. If I wait and as already intimated by Judge Davis, that Donations Tax (and Estate Duty of course) is perfectly likely to increase. A donation now will make sure that the Government’s plan does not denude my Trust’s assets at the time of my death and enable those assets to be applied to the welfare of my wife and my children. A bitter pill to swallow but then I suppose, like most medicines, one has to endure the bitterness to get the benefit.
27th September 2016