The recommendations of the Davis Tax Committee (DTC) regarding the way trusts should be taxed going forward may mean that trusts will no longer be the best vehicle for preserving wealth over the long term.
The DTC released their draft report on all aspects of wealth taxes in South Africa on 13 July 2015. The DTC looked among other things at the way that trusts are taxed in South Africa and noted that the attribution rules as contained in s. 7 of the Income Tax Act were added to the Act at a time when the maximum tax rate of individuals was much higher than that of trusts. It therefore made sense for individuals to transfer income-producing assets to trusts in order to save tax.
The intention with the attribution rules was to tax the income attributed to the trust as a result of such a transfer in the hands of the person who transferred the asset to the trust under certain circumstances. This would have ensured that the income is taxed at the higher tax rate of the individual.
Over the years the tax rates have changed in such a way that the trust is now taxed at the higher tax rate. The application of the attribution rules therefore now has the effect that the individual mostly pays less tax on such attributed income than what the trust would have paid.
The second aspect considered by the DTC with regard to trusts is the so-called conduit pipe principle. This principle allows trustees to distribute trust income during the year in which it was received by the trust to trust beneficiaries where it will be taxed at a lower tax rate than in the trust. This principle has been part of the South African law for a long time and has also been codified in s. 25B of the Income Tax Act which regulates the taxation of trusts and their beneficiaries.
In their report the DTC pointed to the tax regime currently applicable to trusts to be one of the major reasons why so little estate duty is collected every year. The DTC comes to the conclusion that if trusts are made unattractive from an income tax perspective, far less people would use it to protect their wealth against estate duty. This should increase the annual collection of estate duty going forward which currently makes out only 0.1% of all tax collections.
One of the DTC’s recommendations is therefore to repeal the attribution and conduit pipe provisions insofar as they apply to South African trusts so that all income received and taxable capital gains realised by trusts are taxed at the fixed rate of 41%.
The DTC report on wealth taxes has already been given to the Minister of Finance in January this year (2015). In their report they noted that the implementation of their recommendations will have far-reaching implications for taxpayers. They therefore recommend that an extensive consultative process be followed before the implementation of these recommendations and that these recommendations only be implemented with effect from 1 March 2016. The fact that the content of this report was only released for public comment last week (13 July 2015) leaves too little time for taxpayers to consider their options and the implementation date should, for the sake of fairness, be postponed.
The question however is what taxpayers with trust structures should do now?
However, the attribution rules and in particular the conduit pipe provisions have both been a headache for the tax authorities for a long time and it is therefore quite certain that these provisions will be repealed in the end.
Tenk (FH) Loubser is a director of TLA Wealth and Advisory Services. view profile>
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