1. Curiouser and curiouser

Trusts are fantastically peculiar and continue to confound jurists and legal scholars and have been doing so for hundreds of years.

In some ways it works like a partnership, where the trustees acting in concert in their official capacity constitutes the trust. Yet, when a trustee is replaced by a new trustee, the trust is not legally dissolved, as is the case with a partnership. Then, like a partnership, a trust does not have legal capacity like a company or a closed corporation.

The South African Revenue Services, however, considers a trust to be a taxpayer in its own right yet does not afford such lofty status to a partnership.

Partnerships, closed corporations, and trusts do not separate ownership from control as a company does. Members of a closed corporation, partners in a partnership and trustees in a trust constitute both the owners and managers of the enterprise, while with companies, ownership and management are clearly separated.

Partnerships are legally terminated on death of a partner, with the remaining partners constituting a newly constituted partnership. Trusts and closed corporations keep their legal standing and form, notwithstanding the changes of the guard.

To say that trusts suffer from a severe bout of an identity crisis would be the fiduciary understatement of the century. It is our proverbial middle child of estate planning – but we still love it.

2. In middle children we Trust

Of all the vehicles set up to safeguard our assets and provide ringfencing of risk against the wild wild west of death, divorce, creditors, and spoiled descendants, a trust is the only one where asset can be beneficially held without the need of personal ownership of the vehicle itself.

That is why this middle child of structures are deeply loved by affluent individuals and their fiduciary advisors alike.

The trick with trusts (and let us admit, dealing with middle children are tricky) is getting stuff in it. The higher the net asset value of a trust the deeper the mutual love between the trust and it is adoring beneficiaries. – everyone loves a wealthy middle child, right?

The good news is that funding a trust is as easy as 1,2,3.

3. Option 1: Lend the trust some love

Trust can be funded through loans. In most cases trusts enjoy benevolent funding from its creator through interest free loans. It can either be cash transferred to the trust on loan, or it can be assets sold to the trust with the payment obligation taking the form of an interest free IOU.

In South Africa, our revenue services visit donations tax (between 20% and 25%) annually on such a benefactor on the amount of interest foregone. The funder therefore quickly realises that no good deed will go unpunished and needs to fork out donations tax every year for funding the trust in excess of R1.3 million through an interest free loan account.

4. Option 2: Give the Trust some love

Trust can also be funded through a donation. Either money or assets can simply be donated to the Trust. This is great for the net asset value of the Trust, but again, SARS is close on hand to spoil the bar mitzva, by charging donations tax on the full value of the donation.

SARS also keeps a track of the growth in the trust resulting from the benevolence of the funder in both options 1 and 2 and attributes taxable gains (income or capital gains) back into the hands of the funder to the extend that SARS can argue that there is a direct correlation between the benevolence shown and the gains made in the Trust.

In short: Trust makes the money and keeps the money, but the funder picks up the tax bill (very much like paying a child’s varsity fees – you pay, they keep the salary afterwards).

5. Option 3: Give the legacy of love

The third option in the 1-2-3 is surprisingly efficient, but a lesser known and a lesser seen variant.

Trusts can be funded through an inheritance. Assets bequeathed to a Trust has the same net asset value effect on the Trust as option two, but SARS does not visit donations tax on the funder (the Testator/Testatrix) as estate duty is payable (also at between 20% and 25%). No attribution of gains apply as the funder is deceased – collecting tax from a person in this disposition is a tad tricky (do not underestimate SARS in trying to find a way though).

6. Which is best?

Option one comes with a number of benefits that is not always that obvious, but both the section 7C donations tax and the attribution of income and capital gains made as result of the gratuitous loan, reduces the value of the estate of the natural person funder relative to the net asset value of the trust. The estate plan therefore works as the natural person is impoverished in favour of the trust.

Option two is like the middle child of a middle child. It is mainly used when estate planning is required for end-of-life scenarios; where donating assets to a trust and paying donations tax at the same rate as estate duty, is more efficient than having the assets be transferred to loved ones through the cumbersome process of a deceased estate.

Option three is like the “laat-lammetjie” of the funding options, and should neither be underestimated, nor ignored.

7. The moral of the story

When setting up a trust, ensure that your Will is updated to bequeath assets to the trust, rather than directly to the next generation. It makes a stark difference in the estate planning of the next generation.

Similarly, if the next generation has set up trusts already, bequeath assets into those trusts than to the individuals directly.

It is a simple change in a single sentence in a Will, which makes a massive difference.

(Disclosure of interest: the author would like to disclose that he is youngest of his siblings and might have a direct and subjective interest in some of the views expressed above)

By LS Venter