COVID-19 induced reduced returns may provide a window of opportunity
When a trust no longer serves its original purpose or its assets have been distributed to the beneficiaries, there are several important aspects to consider.
The distribution will trigger a capital gains tax event. The question is what the difference is between the market value of certain assets and their base cost. Any positive difference will be subject to capital gains tax.
The next question is in whose hands the capital gain will vest as there is a material difference between the tax inclusion rate for the trust and that for individuals. The result of this difference is that a trust pays capital gains tax at a flat rate of 36% of the taxable gain, while the rate for individuals varies from 7.2% to 18% of the taxable gain, depending on the individual’s marginal tax rate. From a tax point of view, it would make sense therefore to extract your family home or other fixed property by way of a distribution to a trust beneficiary. Here it may be possible to use the municipal valuation as the transfer consideration No transfer duty will have to be paid on such a distribution. If the municipal valuation is less than the original value at which the trust acquired the property, then there would also be no capital gains tax to be concerned about.
What to do
The first step is to start with the constitution of the trust, namely with the trust deed. Make sure that the trust deed provides the necessary powers for early termination and ascertain whether any capital gain can be vested in a beneficiary.
The next step is to calculate the position as regards potential capital gains tax. Here Covid-19 may have provided you with an unintended benefit. Where a trust owns shares in a private company that is trading, the value of the shares may have been adversely affected by prevailing trading conditions. Consult your auditor for a net asset valuation. Capital gains tax may be negligible. The net asset value of any holding you may have in a private company as determined by your auditor may also be such that any capital gain may now be small or non-existent. Covid-19 has also had a negative impact on the property market. There seems to be an oversupply of properties with some children having to move in with their parents as they have lost their jobs.
Many founders of trusts have been affected by Section 7C of the Income Tax Act which specifically deals with interest free- or low-interest loans to trusts. The aim of Section 7C is to prevent estate duty avoidance that could result when a person transfers a growth asset to a trust, in return for a fixed loan that does not grow in value, because no interest is charged on the loan. If Section 7C is a problem for you, now may be the time to reconsider the merits of having a trust, as the window of opportunity will not be too long as markets show signs of recovering, albeit slowly.
De-registration of the trust is the next step
Note that once a trust has been distributed it is not the end of the process.
In order to de-register the trust with the SA Revenue Service you need to first de-register the trust with the Master of the High Court. The Master has its own requirements for this. Unless you attend to this de-registration with the Master you will have to continue submitting returns to SARS although they may be nil returns. Furthermore, you will continue to have to pay your tax practitioner until no more returns are required.
Bear in mind that terminating a trust requires the same attention as when you started it. It must be done with the necessary skill and not in isolation to your estate planning – for example, how does it affect your will and post-termination planning?
A fiduciary expert, ideally a Fiduciary Practitioner SA® (FPSA®), can assist you with terminating a trust properly and does not have to be one of the existing trustees.
Just a final word on this – before you decide to terminate your trust, the most important question is to weigh up whether you should keep your trust for the principal reasons for which it was probably set up – the safeguarding of assets from one generation to the next, the protection of assets against your business risks, and/or the protection of beneficiaries.
By Nico Botha, FPSA®, a member of FISA, and Director ST&T Executors and Trustees