Section 7C was enacted to limit the estate duty savings that result from an interest-free or low-interest loan to a lender-connected trust. It’s not always just about the tax benefits or the additional taxes owed on assets moved to a conviction; it’s also about a strategy to protect your assets and provide continuity and liquidity after your death.
There are also additional factors to consider, such as a backup plan if you develop Alzheimer’s disease.
With so many people creating trusts as part of their estate plans, the founders, beneficiaries, and trustees may end up using trust assets, such as living in family homes that have been transferred into trusts, to either protect their assets during their lifetimes or to ensure continued use of the assets after their deaths.
Suppose a trust arrangement is not used for real commercial or estate planning goals, as the FNB v Britz case detailed in the previous column. In that case, a court will not hesitate to rule that the assets do not belong to the trust but to the individual who used the trust as a façade. The fundamental objective of forming the trust will be defeated in this situation. This could result in creditors having access to these assets, or Sars include trust assets in a deceased person’s estate, triggering estate duty.
Using the facts of the FNB v Britz case, these punitive provisions would not apply to the loan advanced for the funding of the primary residence transferred from the Britz couple to the trust, as long as the lender or the lender’s spouse used the primary residence during the year of assessment that the faith held the home; this is a specific exclusion. However, if someone else uses the place, even for a short time, this exception will be lost, and an interest-free or low-interest loan will be subject to taxation.
Section 7C would apply to any loans that aren’t for the primary dwelling.
Instead of the value of the household contents, they transferred to the trust in the FNB v Britz case. The trustees’ loans were unsecured, did not bear interest, and had no detailed payback requirements. These are common terminology used in family trusts. Section 7C would be applied to these loans because they did not carry interest at least at the official rate (now 7.75 percent per year).
Because of the increased focus of Sars on the wealthy, the most recent tax return for trusts contains highly-specific questions about how trust assets should be treated.
Regarding the use of trust assets, Sars expects trustees to state on the trust tax return if someone has the right to utilize assets held in the trust and information of the trust’s expenses related to the use of trust assets. Trustees will have to be cautious when dealing with trust assets due to this.
The first issue emerges from a trust’s distinctive characteristic, which allows it to have different capital and income beneficiary classes made up of other people. As a result, the trustees must equitably allocate trust expenses among various categories of beneficiaries, which may affect the amount available for distribution to each class.
Furthermore, because the trustees can use the conduit principle (a principle unique to trusts in which trustees can decide to push income or capital gains down to beneficiaries, allowing them to pay tax at their lower tax rates instead of the trust) to distribute any income or capital gains, as well as related expenditure, to beneficiaries, the apportionment of payment will have to be defendable by the trustees.
Trusts are frequently used to conduct business and hold assets. In this case, it’s critical for the trustees to allocate expenses properly and only allow payments to be deducted from income to the amount incurred in the generation of that income. Suppose a beneficiary, for example, uses trust property for free. In that case, the trustees will be unable to shift any expenses paid on that property to other trust income to minimize the trust’s tax liability. Sars will be able to determine whether the above-described Section 7C exclusion will apply to such use of the trust property by answering the question on the tax return mentioned above.
If someone is working as an employee of a trust-run business and is given free access to trust assets, that access may be counted as a fringe benefit and subject to employee tax.
Trustees must put forth an effort and apply their minds in the trust administration to defend the use of trust funds and the allocation of trust expenses.
Their actions must show that they treat trust assets apart from their own for the benefit of all beneficiaries and keep adequate trust records of their decisions and execution. Without it, Sars may be able to attack the trust.