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“The secret of getting ahead is getting started” (Mark Twain)

That’s great advice from Mark Twain, so if you are sure that you are cut out for the exciting, hurly-burly life of an entrepreneur, and if you have a viable business concept, take advice now on how to get started.

In a previous article we looked at the private company option. In our final article in this series we consider the plusses and minuses of trading in a business trust.

What is a business trust?

In summary, a trust is a contractual arrangement that allows trustees to hold assets (without owning them) for the benefit of the trust beneficiaries.

Most trusts are not “business trusts” – they are just used to hold assets. In the case of “living” trusts (the type of trust most likely to be encountered in this context) assets are initially provided by a “founder”, “settlor” or “donor”, and then owned, controlled and managed by trustees in their capacities as such (not in their personal capacities), for the benefit of beneficiaries. The trustees can, and usually do, acquire more assets for the trust thereafter, again just to hold/control/manage.

With a business trust the trustees go one step further – they trade for profit, again for the benefit of the beneficiaries.

Strictly speaking, trusts aren’t separate legal entities like partnerships and companies, but in practice they are often treated as though they were, and some legislation (tax in particular) specifically defines them as such.

5 advantages of business trusts …

1. Trusts, like companies, have “perpetual succession”, so they survive the death/incapacity/insolvency/removal of trustees, with all the practical benefits that entails. For example, the business can continue to operate normally after the death of the founder or trustees, rather than be tied up in the process of winding up the deceased estate. And trusts that are properly created and administered can protect assets from creditors in the event of insolvency, divorce etc of the founder/trustees/beneficiaries.
2. The trading risks of the business lie with the trust i.e. the trust’s assets are at risk from trading liabilities, not the personal assets of the parties to the trust. Trustees, unless of course they have signed personal suretyship for any trust debts, generally risk personal liability only if they fail to comply with the provisions of the trust deed and other legal requirements. In particular they have very strong fiduciary duties towards beneficiaries, and must always act in their interests. They must also observe the fundamental requirement that trust assets be treated as such, and not as their personal assets.
3. As is the case with companies, you may find it easier to raise funding for a trust than for a sole tradership or partnership.
4. Tax: Possibly an advantage … see below.
5. Savings on death: Trusts have in the past often been used to freeze the value of growth assets as part of an estate planning exercise to reduce estate duty, capital gains tax and executor’s fees. These savings can be substantial, but be aware of factors such as the high tax rates applicable to trusts (see below) and of the various recommended changes to our tax and estate duty laws (such as the Davis Tax Committee proposals) which could – if they are ever implemented – reduce the attractiveness of trusts for this purpose.

… and 3 disadvantages

1. Formation: Like companies, trusts require formal procedures for formation in the form of drawing up and registration of a trust deed, and appointment of trustees by the Master of the High Court. Factor the resulting delays and costs into your plans. Don’t take shortcuts here! An incorrectly worded trust deed for example will cause you all sorts of unnecessary pain.
2. Costs of administration will generally be higher than with sole proprietorships although typically lower than with companies. But check upfront with your advisors what you will be in for.
3. Tax: Possibly a disadvantage … see below.

The tax angle

As with all the other possible trading entities you can choose from, it is impossible to give general advice here. But as an overall comment, trusts have lost a lot of favour in recent years as a result of various government “attacks” on trusts, and they are now highly taxed compared to individuals, partnerships and companies. Apart from generally being subject to higher rates of tax, they are also denied the various tax exemptions and rebates available to individuals.

There are a host of factors to be considered here, and you need to seek advice tailored to your particular circumstances. For instance, it may or may not affect your business trust that the primary residence CGT exemption isn’t available to trusts.

Moreover government has given out strong signals that this “hostile” trend will continue. In 2017 already, interest-free and low-interest loans to trusts have become subject to the risk of being taxed as donations. Now the “conduit principle”, whereby income can be taxed at personal rates in the hands of beneficiaries rather than in the trust at a flat rate of 45%, is reportedly under threat.

Even more so than with other types of trading entity, it is essential to get specific guidance on whether a business trust is the most tax-efficient entity for your particular situation.

The bottom line is this – take full professional advice on both the legal and the tax implications of using each type of entity (or any combination of entities) before you start trading.

A recent Supreme Court of Appeal (SCA) decision illustrates once again how essential it is, before getting married, to have your lawyer structure your antenuptial contract (ANC) correctly, and with as much detail as is needed for certainty.

A multi-million Rand fight over trust assets

• A divorcing couple had married and divorced three times.
• They had in respect of the latest divorce been married out of community of property with the accrual system, so each was in principle entitled to 50% of all “accrual” (growth) in their estates after marriage, except as specifically excluded from accrual by their ANC.
• The husband had, on the advice of his accountant, created a new legal entity for each of his new timeshare business ventures, in order to ensure that if one business failed, the others would not be affected.
• In their ANC the couple had specified which of the husband’s assets (including interests in business entities such as trusts, CCs and companies) were excluded from the accrual.
• On divorce, the wife asked the High Court to declare the assets of three trusts to be assets of her husband for the purpose of accrual on two grounds –
  • That on the facts and on interpretation of the ANC they were not excluded from the accrual, alternatively
  • That the trusts were simply the husband’s “alter ego” so that the assets of the trusts were in reality her husband’s assets.

The outcome, the law, and the lessons to be learned

The SCA held that none of the trusts’ assets were to be taken into account in determining accrual in the husband’s estate –

• In respect of two of the trusts, on the particular facts of this case they weren’t covered by the exclusion clause which provided that exclusion was to extend to “any other asset acquired by such party by virtue of the possession or former possession of such asset”. The Court rejected the husband’s argument that this should be read widely to exclude “any asset acquired as a result of his activities in the timeshare industry” – it only covered “the particular asset, its proceeds, and assets which replace the excluded asset or are acquired with its proceeds”.

Lesson 1 therefore is this – if you want a wide exclusion of a particular class of assets from the accrual process, say so clearly in your ANC.

• However, the wife also had to convince the Court that the trusts were the “alter ego” of the husband.

She was able to convince the Court that he had “administered the trusts with very little regard for his fiduciary duties as a trustee and without proper regard for the essential dichotomy of control and enjoyment essential to the nature of a trust and … such conduct may have justified his removal as a trustee, or the appointment by the Master of an independent co-trustee…”

What she had failed to prove was any “abuse of the trust form” nor that “the trust form [was] used in a dishonest or unconscionable manner to evade a liability, or avoid an obligation.”

Firstly, the husband’s use of separate trusts for each new business venture was a “legitimate business activity” given his “overall business strategy”.

Secondly, there was no proof that the husband “transferred personal assets to these trusts and dealt with them as if they were assets of these trusts, with the fraudulent or dishonest purpose of avoiding his obligation to properly account to the respondent for the accrual of his estate. In addition it was not established that the transfer of assets to these trusts by the appellant was simulated with the object of cloaking them with the form and appearance of assets of the trusts, whilst in reality retaining ownership.”

Lesson 2 therefore is that if you want to attack your spouse’s use of trusts to hold assets you will need to prove more than just misconduct in the administration of the trusts. You will also have to prove a fraudulent or dishonest attempt to avoid the consequences of accrual.

Hopefully you won’t have to wait 20 years for your new dream home to be built – that’s how long Cheops (ancient Egyptian pharaoh) had to hang around twiddling his thumbs whilst his Great Pyramid of Giza was going up – but you will no doubt be keen to move in as soon as you can.

But before you do so you must obtain a “Certificate of Occupancy” from your local municipality. This applies whether you are moving in yourself or putting in a tenant. It also applies both to building from scratch and to carrying out any “alteration, conversion, extension, rebuilding, re-erection, subdivision of or addition to, or repair of any part of the structural system of, any building”.

Why bother to comply?

1. Firstly, if you don’t comply, you will have problems with your bank if your home is mortgaged, and – perhaps more critically – you could find yourself without insurance cover.
2. Secondly, you won’t be able to arrange water and electricity accounts and connections from the municipality.
3. Thirdly, it is a criminal offence to occupy or use (or permit occupation or use) of the building without authority (or to the extent that “it is essential for the erection of such building”).

A couple of notes here –

• In necessity you may be able to get temporary, conditional permission to use a building before the Certificate is issued.
• If the building later falls into disrepair or is deemed unsafe, the municipality may revoke the Certificate.
• If you are moving into a new/renovated building as a tenant, ask for a copy of the Certificate from the landlord to ensure that your occupancy is lawful.

How does the Certificate protect you?

The municipality will only issue the Certificate once satisfied that your building is fully completed in accordance with the approved building plans, that all conditions of approval and other municipal requirements have been met, and that all necessary compliance certificates (structural completion, electrical, plumbing, gas and so on) have been issued.

The end result – assuming of course that the municipality has done its job properly – is confirmation that your builder has complied with all regulations and requirements. For both safety and financial reasons that’s an important protection for both you and your family, and for any tenants or other occupiers.

Who must obtain it?

In practice your builder or project manager should obtain the Certificate for you after final municipal inspections have confirmed compliance as above, but make sure you get it before you take occupation. Then file it away somewhere safe in case of future problems or queries.
Ask for help if you run into any problems here.

“… the difficulty experienced by bodies corporate in collecting arrear levies is not a novel one. It is part of a ‘socio-economic problem’ ” (extract from judgment below)

Levy collections are the life blood of sectional title schemes, and collecting them is likely to get harder with the economic fallout from our downgrade to junk status.

So if you own property in a scheme, and particularly if you are a trustee of your body corporate, you need to know about the new SCA (Supreme Court of Appeal) decision which puts at risk the body corporate’s right to apply for sequestration of levy defaulters.

Why apply for sequestration?

Applying for the sequestration of a recalcitrant debtor’s estate can be a very powerful debt collection tool.  But it should generally only be used as a last resort, and it isn’t always open to you.  The facts of the SCA case provide a perfect example –

• Two sisters jointly owned a sectional title unit, bonded to a bank.
• When the sisters fell into arrears, the body corporate obtained judgments against them for a total of some R115k.
• Their movable assets were sold by public auction, but for only R3k.
• The body corporate then obtained a warrant of execution against the unit and sold it for R170k. The sale however was abandoned when the bank refused to accept the selling price.
• Having exhausted “all reasonable execution remedies”, the body corporate applied to the High Court for the sequestration of one of the owners.  The clear benefit to the body corporate of doing so was that the trustee of the insolvent estate would have sold the unit, and – per the Insolvency Act’s provisions – the arrear levies claim would have been paid as “a cost of realisation” i.e. before the bondholder’s secured claim.
• Unsurprisingly, the bondholder opposed the sequestration application, arguing that as its bond instalments were up to date, no creditor would benefit from a sequestration other than the body corporate.
• The High Court refused to order sequestration, and the SCA upheld that decision on appeal.

There must be advantage to creditors as a whole

To understand why the body corporate’s application failed, we turn to the Insolvency Act’s requirement that there must be “reason to believe that it will be to the advantage of creditors of the debtor if his estate is sequestrated”.  Bear in mind here that on sequestration what counts is creditors in the plural – as the Court put it “the rights of the creditors as a group are preferred to the rights of the individual creditor.”

In a nutshell, to succeed in sequestrating a debtor’s estate, you need to prove “a tangible benefit to the general body of creditors”.  There should be “a reasonable prospect of some pecuniary benefit to the general body of creditors as a whole”, a requirement that will be fulfilled “where it is established that there is reason to believe that there will be advantage to a ‘substantial proportion’ or the majority of the creditors reckoned by value”.

The body corporate failed in this case because it was unable to show pecuniary (monetary) benefit to any creditor other than itself.

Catch-22, and nipping arrears in the bud

“A catch-22 is a paradoxical situation from which an individual cannot escape because of contradictory rules” (Wikipedia)

That leaves bodies corporate in a real “catch-22” situation.  You are obliged by law to collect levies, but you risk not being able to do so if you have to rely on what should be your strongest fall-back position – realising the value in the sectional title unit itself.

The bottom line for bodies corporate is this – unless and until our laws are changed to grant bodies corporate immunity from the Insolvency Act’s provisions, you need to prioritise and strengthen your levy monitoring and collection procedures so as to nip any arrear situations in the bud.

You rent a house and the geyser packs in or the pool starts leaking. The landlord ignores your pleas to fix the problem – or outright refuses to do so. Can you go ahead and do the repairs yourself, then deduct your costs from your rental payments?

A recent High Court case illustrates the dangers of doing so.

The tenant who charged for repairs then short-paid his rent

• A tenant claimed to have incurred costs in remedying a long list of defects in the rented house, including doors without keys, electrical repairs, pool motor repairs, re-marbling of the pool, a gate motor, installation of a geyser, and others.  He even billed the landlord for 5 hours of his time spent fixing a water pipe (at “double rate since it was in the midnight hours”).
• He deducted his charges and costs for these repairs from his rental payments and then, in arrears to the tune of over R200k, defended an eviction application against him on the basis that the landlord had authorised the repairs and deductions.
• The landlord denied having authorised any repairs, and it didn’t help the tenant’s case that an upfront inspection of the premises (jointly with the landlord’s agent) had failed to reveal any of the defects complained of.  In any event his defence was completely destroyed by the specific terms of the signed lease –
  • No alterations to the house or its fittings could be made except with the landlord’s prior written consent.  The tenant was unable to produce any written proof of consent, let alone persuade the Court that he even had verbal consent.
  • The tenant couldn’t claim any compensation for any alterations or additions to the premises or its features, whether with the landlord’s consent or without it.
  • Rental and all other amounts payable had to be paid on time, monthly in advance, “without any deduction or setoff whatsoever”.
  • Any changes to those clauses had to be in writing and signed by both parties to be valid.
• The Court accordingly gave the tenant 30 days to vacate or be evicted by the Sheriff.

So who pays for what?

Landlords have a number of statutory obligations in relation to maintaining the house in good order and repair, but beyond that what counts most is the provisions of the particular lease that you sign.

So before you sign anything make sure you understand exactly what you are letting yourself in for. Pay particular attention to clauses specifying who must do what by way of repairs and upkeep – you will probably be responsible for minor and day-to-day maintenance issues but watch out for those landlords who try to put a much heavier burden on you.

Two final tips

1. Don’t make the mistake that the tenant in this case made, of not identifying and recording all defects in the premises in a joint upfront inspection.
2. Both landlords and tenants should take photos of every part of the house before occupation and again after vacation.  An app like “Guard My Lease” may help in resolving any later disputes.