Trusts

There seems to be a lot of ignorance about how trusts operate and what their advantages and disadvantages from an income tax point of view are. A trust is an arrangement between one person the founder and another person the trustee in terms of which assets are entrusted to the care of the trustee for the benefit of another person the beneficiary. Trusts are formed either by a stipulation in a will or by a founder who is still alive. The latter type of trust is referred to as an inter vivos trust while the former is termed a testamentary trust. The Income Tax Act contains specific provisions that are meant to curb taxed avoidance arrangements. This is due to the peculiar character of a trust. Generally speaking any income that is distributed by a trust to a beneficiary during the same year in which that income was earned retains its character in the hands of the recipient beneficiary. Thus for example a dividend that is received by a trust and that is immediately distributed to a beneficiary would remain a dividend for the purpose of income tax in the hands of the recipient beneficiary. Hence the ante avoidance provision Where a person makes a donation to a trust on condition that the beneficiaries of the trust would not enjoy the income earned by the trust until the happening of an event any income in consequence of such a donation is deemed to be the income of the donor until the happening of that invent or the death of the donor whichever comes first. A word of warning An interest free loan may under certain circumstances be classified as a gratuitous disposition in which event donations tax becomes payable. Further the income in consequence of such a donation would be deemed to be the income of the lender One of the big advantageous of a trust is that it is possible for the trustees to distribute the income that accrues to the trust to various named beneficiaries of the trust in such proportions as they may deem fit. Thus in this manner the trust and all the beneficiaries who benefit by the distributions of taxable income share the tax burden. Why do I need a trust? One instance in which a trusts is very useful is the situation where a parent has a child that is for some or other reason incapacitated. In practice such a parent would place a sum of money in the hands of a trustee for the ultimate benefit of an incapacitated child. Under these circumstances the trustee cannot use the money for his own purposes and is obligated to invest the capital to the best of his abilities for the benefit of the child in our example. It is also useful to stipulate in ones will that upon the death of both parents certain funds should be kept in trust for minor children until they reach a stipulated age. How do I create a trust? When a founder places funds or assets in the care of a trustee he normally draws up a trust deed that contains all the provisions relating to the administration of the trust in relation to the assets or cash that is how the funds should be managed for the benefit of the beneficiaries. There are no off the peg trust deeds and all persons who believe they are in need of a trust are advised to consult a professional person. A word of warning though The creation of a trust must be based on a commercial purpose otherwise the founder runs the risk that it may be completely ignored for the purpose of income tax. Thus although the creation of a trust may be absolutely normal in an estate plan it may still be abnormal for the purposes of income tax. Income tax The tax rate that is applicable to a trust is 40 percent of taxable income. The flat rate of 40 percent does not apply in the case of trusts established for the benefit of a person who suffers from a mental illness or a serious physical disability. Special trusts as these trusts are referred to are taxed at rates that are applicable to natural persons. Rebates Trusts do not qualify for any rebate similar to the rebate applicable to natural persons. Tax returns One must keep in mind that an income assessment by the Receiver of Revenue cannot be re-opened by him after the expiry of three years from the date of the assessment concerned. That means that where for instance an error is discovered by the Receiver after three years from the ate of the assessment he is not allowed to re-assess you in respect of that year any difference must be written off. This general rule however does not apply in instances where there was non-disclosure of material facts. Thus it is important that tax forms must be completed correctly and reflecting the trust state of affairs. Also note that the claiming of a deduction of losses or expenses in the determination of taxable income that are not allowable in terms of the Income Tax Act is deemed to be a non- disclosure of a material fact. Thus the completion of income tax forms is important. Type of trusts A very brief summary of a trust is A trust is an arrangement between the creator thereof referred to as the founder and another person a trustee normally in terms of which assets are held by the trustee for the benefit of certain persons referred to as beneficiaries. Trusts fall mainly in two categories namely inter vivos trusts and testamentary trusts. Further inter vivos trusts may be vesting trusts or discretionary trusts. In a vesting trust the beneficiaries are normally entitled to the assets of the trust but may only take possession thereof upon the happening of an event such as when the beneficiary reaches a certain age. Assets and income of a discretionary trust on the other hand may normally only be distributed in terms of the trustees discretion. Tax return Questions 18.7 and 18.8 read with Part 9(B) of the tax return are important and we advise those who are not familiar with tax law to consult a professional. The questions refer to section 7(3) and 7(5) of the Income Tax Act. The first applies to minors and the second applies to other persons. Very briefly Section 7(3) deems income by reason of any donation settlement or disposition to be that of the parent if the child has received it or if it has been accumulated for the benefit of that child. Section 7(5) provides that if any person has made a donation settlement or other disposition which is subject to a condition that the beneficiaries shall not receive income thereunder until the happening of an event any income in consequence of such donation settlement or disposition shall be deemed to have been received by the donor. Interest free loans There has been an income tax case of a father who made a loan to his daughter. On the facts of that case the loan was held to have been made gratuitously with the result the section 7(5) was applied. The father made the loan on a basis that ignored normal commercial terms. The lesson is that one must realise the consequences of making an interest free loan on terms that will fit the concept donation settlement or disposition. Recommend this article...