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Trusts as an Investment Vehicle

Published: May 1, 2013 by Gordon Stuart, Sentinel

The principle reason why trusts are not used more often as investment vehicles is because of the perceived higher tax rates applicable to trusts. To avoid the perceived higher tax rates the investor inevitably acquires the growth asset in their own name whereas if they had acquired the asset in the trust they could have achieved short-term tax benefits as well as saved on the long-term death duties such as deemed capital gains tax, executors fees and estate duty tax. This does not mean that everyone should rush out and form a trust to hold their capital appreciating assets. If there is not a material, economic reason behind the establishment of a trust then other alternatives should be explored. Furthermore, it is generally not necessary to establish a multitude of trusts. Simplicity is often the best solution and one trust can achieve the same results and benefits.

When determining whether a trust is the correct vehicle to be used the following factors could be taken into consideration:
a) The nature and value of the assets that the planner swishes to acquire,
b) The age of the planner,
c) The expected yield that will be produced by the assets. This yield can either be in the form of income or capital appreciation or both,
d) The fundamental reasons behind wanting to establish the trust.

As stated earlier there are both short-term and long-term tax benefits in holding income producing and/ or capital appreciating assets in a trust. Due to the unique nature of a trust from a taxation perspective the trustees have the ability to determine how they wish to deal with the taxable income and or capital gains on an annual basis. It must be noted that there are certain limitations to this ability to distribute taxable income and/or capital gains to beneficiaries. If the beneficiary is under the age of eighteen and is the child of the person who lent the money to the trust then the income will be deemed to belong to the parent anyway. For the rest though, the trustees have the unique ability to ascertain which beneficiaries have the lowest tax rates and to then distribute the taxable income to these beneficiaries. The net effect is that the overall tax on the income / capital gains is reduced.

The long-term tax benefits of a trust apply to the savings in death duties. Death duties can be broken down into three percentage based costs, namely deemed capital gains tax (at a maximum of 13.3%), executor’s fees (at a maximum of 3.99%) and estate duty tax (20% on the net value of the estate which exceeds R3,5 million). When the planner transfers assets to a trust, he/she generally does so via an interest-free loan. This loan is static and will not increase unless the planner transfers additional assets to the trust. The first benefit of this transfer of assets is the removal of deemed capital gains tax on death as there is no capital gains tax on a loan account. As the loan account is pegged so too is the associated executors fees and estate duty tax. If the trust receives dividends from its investments and the planner requires these dividends to supplement his/her lifestyle then the trust can utilise these already taxed dividends to repay the loan owed to the planner. This achieves a double benefit – the growth of the investment takes place outside the planner’s estate and the value of his loan account is reduced thereby reducing his death duties.

In conclusion, by applying the relevant sections in the Income tax Act a planner should never have to pay more income tax as a result of a trust owning the asset than if he or she had held the assets in their own name. However, there is the possibility that the trust can be used to lower the overall effective tax rate.

Gordon Stuart is the Chief Operating Officer at SentinelHe has a Bachelor of Commerce Degree in Law from the University of South Africa, a Certificate in Advanced Trust Law from the University of Pretoria, an Honours Degree in Tax Law from the University of South Africa and a Masters Degree in Finance and Estate planning from the University of the Free State.   Gordon is a full member of the International Society of Trust and Estate Practitioners (TEP).  He is also currently completing a Magister Legum (LLM) degree in Taxation.   After graduating, he was appointed as group accountant for investment, I.T. and asset financing companies.  He joined a trust company in Cape Town and later started Genesis Consulting (Pty) Ltd.