In an ever-changing financial environment, many people seek the security of their assets. From protecting their assets from creditors and legal obligations to reducing future tax liabilities the role of a trust may prove valuable. This article unwraps the role of trusts in asset protection, various considerations before establishing a trust, and how a trust may aid your financial planning.
The use of a trust is ideal when an individual seeks to move assets out of their personal capacity and into the management of others. By transferring the assets into the trust, the individual ceases ownership of the assets. This transfer can be beneficial to those who do not want to hold the assets in their own capacity for various reasons. A trust is a legal relationship where assets are transferred into the safekeeping of the trustees of the trust to provide for the nominated beneficiaries. There are various role players when forming and managing a trust. The role of the trust founder is to determine the purpose of the trust and transfer the initial assets into the trust. The role of the elected trustees is most important as they will manage the assets in the trust, they have the power to make decisions regarding the assets held in the trust, for the sole purpose of benefiting the nominated beneficiaries of the trust. The trustees should be financially astute, good decision makers and it would be preferential that they have experience in this role. The nominated beneficiaries of the trust have the right to benefit from the trust. However, the manner in which these beneficiaries will receive the benefit will be stipulated in the trust deed and whether the trust is a vested trust or a discretionary trust. The trust deed is essentially the instruction manual for the trust, this explanatory document should include the precise details of the trust and the administrative process.
There are various scenarios where a trust is advantageous, however, the primary purpose is ring-fencing the assets in the trust from your personal assets. A trust serves as an effective tool to safeguard assets from creditors or individuals who are unable to make sound financial decisions, ultimately protecting your wealth). By holding your assets in a trust, these assets are protected from creditors meaning that any personal debt and obligations would not be tied to the assets in trust.
Another prominent use of trust is to leave a legacy through generational wealth in the most effective way. Before setting up a trust, careful consideration should be given to the purpose of the trust. A trust should not be set up with the sole purpose of avoiding tax. The value of the assets held in trust do not form part of your estate at death, effectively reducing your future estate duty and executor’s fee payable upon passing. Estate pegging is when an asset that is expected to increase in value over time, is transferred to a trust at its current value, and any growth following the transfer will occur in the trust. While a trust may assist with reducing taxes in your personal capacity, trusts are not exempt from tax.
It is important to understand the structure of the transfer of assets into the trust. This process is not a simple transfer of assets into the name of the trust. The most common way to structure the transfer is to set it up as a loan from the estate planner to the trust, by structuring it this way donations tax is avoided. However, this structure can take some time as one may only donate up to R100 000 each tax year exempt from donations tax, meaning that the loan will only be written off over many tax years depending on the value of the assets transferred. A further factor to consider is the impact of Section 7C of the Income Tax Act which may deem the non or low-charging of interest on a loan a donation.
It is important to understand the requirements of a valid trust and the strict administration requirements. There will be serious consequences if the trust is believed to be set up as a front. One must be wary of an alter ego trust where a trust is established but the trust founder continues to exercise control and benefits from the trust assets without allowing the trustees to make decisions and the beneficiaries to benefit. For example, a case where the founder is the sole beneficiary of the assets with no intention of benefiting the beneficiaries. While the trust may be valid and meet the requirements, the trust founder fails to act with the necessary care, diligence, and skill required in terms of the Trust Property Control Act. The consequence of this is that the creditors may attach their claim to the assets in the trust and request the court to investigate the assets in the trust. This may lead to the court viewing the assets as if they were never held in trust, meaning they are no longer protected in trust, which takes away from the sole purpose of the trust in the first instance. A sham trust is where a trust did not meet with requirements of a valid trust when established and the founder intended to create a perception of a trust, the court may deem that the trust never existed meaning that the assets are too not protected.
It is the trustees’ responsibility to report on the accountable institutions they engage with and record the beneficial ownership of the trust. In December 2022, there were further stringent amendments made to the Trust Property Control Act, including a change in the trustees reporting and the introduction of a new definition of ‘beneficial owner’. This has increased the administrative burden on the trustees to meet the requirements set out by the FIC Act. Failing to adhere to these requirements, may result in fines due of up to R10 million and imprisonment of up to 5 years, or both.
As previously mentioned, trusts are not exempt from taxes, trusts are taxed more harshly than individuals. Therefore, how the trust will be taxed is an important consideration to manage a trust effectively. In terms of the Income Tax Act, a special trust may be set up to provide for a disabled beneficiary. If the trust qualifies as a special trust, it is taxed as a natural person and in addition can make use of tax exemptions, which is more favourable. There are costs involved with setting up and managing a trust such as the cost of the administration, accountants, and trustee remuneration. Therefore, understanding what outflows are due from the trust’s assets and determining liquidity in the trust.
In summary, a trust is a complex creature with various intricacies that are advantageous in the protection of assets and legacy planning through generational wealth, however, this article highlights the importance of being financially astute when establishing and managing a trust. Understanding the responsibility and accountability of each role player in a trust and the various tax consequences and costs that need to be provided for can set you in good stead for establishing a trust.
Have a fantastic day!
Sue
