/ 14 October 2005

Be cautious about trust funds

Trusts have received some bad press recently as a result of changing tax legislation. Gone are the days where you chucked all your assets into a trust to avoid tax and transfer duty on your property. With the advent of capital gains tax, having your home held in a trust structure means you cannot, for example, take advantage of the R1-million rebate on your primary residence.

Another big change in legislating government trusts is the payment of transfer duties for properties. Until a few years ago, this could be avoided by selling the trust instead of the property.

The tightening of money-laundering legislation internationally has meant that offshore trusts have also lost their status as cosy vehicles to hide your illegal offshore funds from the Reserve Bank and Receiver of Revenue.

However, Tony Barrett, regional manager at BJM Private Client Services, says that while prior to the tax reforms everyone was piling into trusts, today the pendulum has swung and people are no longer making use of this very powerful financial planning tool.

“It is unfortunate that because the issue has become more complicated many financial advisers are steering away from trusts, yet they can offer huge benefits in certain circumstances.”

The idea behind trusts is to provide for estate planning, long-term wealth creation and to protect your assets from creditor attacks. Barrett says you should consider having a trust if you run your own business as this protects your assets from creditors. At the same time he recommends that when starting your business you put your shares into a trust as part of long-term estate planning.

“It is a fallacy that capital gains tax makes trusts prohibitive as the capital gain can be distributed to the beneficiaries and taxed in their hands.” Barrett says that for this reason any long-term asset could be held in trust as the trust can retain the asset while paying out the income or capital gain to the beneficiaries. Testamentary trusts, which are created on your death, are very valuable structures, especially if you have young children or dependants who need to live off the assets of the trust.

However Barrett warns against trying to rule from the grave by making the trust very restrictive and inflexible. For example someone who got badly burnt in the dot.com bubble may try to protect the heirs by stipulating that they may never invest in IT stocks even if the conditions change. “It is important to keep the trust as simple and flexible as possible”.

In addition to estate-planning benefits, offshore trusts are ideal vehicles if you are fortunate enough to receive an offshore inheritance. By paying the offshore inheritance into an offshore trust you are able to preserve the inheritance, draw an income and avoid estate duty.

“If foreign executors pay the money directly into an offshore trust, the funds do not accrue to you or your estate and any amount of the initial capital from the inheritance that you draw down from the trust is tax free,” says Barrett.

Although you will pay tax in South Africa on any income or capital gains that is distributed to you as a beneficiary, if you are drawing down the initial capital to supplement your income locally, this will be seen as a capital distribution from the trust, which is not taxable.

What to look for

Proper record-keeping: You need to ensure that your trustee is keeping reliable records of your trust’s financials. The trustee must be able to prove to the Receiver of Revenue what portion of your distribution from the trust is made up of capital, interest or capital gains. This is especially true of offshore trustees as they need to be abreast of South African tax-reporting requirements.

Value for money: In many cases a trust company will charge a set price for a set range of services and any additional services will be charged for over and above. Be careful of simply going for the cheapest because it could end up costing you far more if the trustees are not keeping proper records in order to cut costs; this could land you up in an investigation by the Receiver. By the same token, a trust company that is charging higher fees must prove what value-added services they are offering.

Who makes the investment decisions: A trustee is not necessarily an investment expert; you need to make sure your investment decisions are being made by a person with the right qualifications.