Trusts and Capital Gains Tax

Such gains are taxed as a capital gain in the hands of the first trust to which they are distributed. This is a blow to all such structures.

Any insurance policies effected as part of such structures may fail to achieve the desired outcome. The bottom line is that as a higher rate of tax than that expected will be payable, the amount of capital ultimately available may be insufficient to meet the actual needs of the natural person.

The taxable capital gain of a trust other than a special trust, is taxed at an effective rate of 36%, while that of an individual is taxed at a maximum effective rate of 18%.

Fortunately for trusts, trustees and beneficiaries, legislation around the taxation of trusts has developed what has been termed “attribution rules”, which in certain instances, provide that trust income, including capital gains, can be attributed to a beneficiary if vested in that beneficiary in the same tax year as the year in which the trust acquires the income, or it can be attributed to the donor of the trust.

Instead of being taxed at the trust’s rate, such income would therefore be taxed at the beneficiary’s rate, which means that not only could this be a lower rate than that of the trust, but also that any exemptions and rebates that the individual may be entitled to, can be used to further reduce the tax payable.

CGT would arise in relation to a domestic trust with resident beneficiaries:

When a discretionary trust vests assets in a beneficiary
In these instances, capital gains will be ignored in the trust and taxed in the beneficiary’s hands at the time of vesting, with the base cost being the market value at the date of vesting. That means that the beneficiary will be liable for the capital gains tax immediately, and then if the beneficiary should sell the asset at a later stage, the base cost for purposes of that sale would be the market value at the date that he received the asset from the trust.

When a trust distributes assets of a capital nature to a beneficiary who had a vested right thereto
After the amendments introduced by the Revenue Laws Amendment Act of 2008, the date of disposal of an asset to the beneficiary is when the beneficiary actually acquired the vested right to the asset, and not when the asset is transferred.

For example: A bequeaths his fixed property to his son B, with the condition that should B be less than 30 years of age at the time of A’s death, such property will be held in trust until B reaches the age of 30. When A dies, the property is valued at R1 000 000, but when B turns 30 years the property is valued at R1 500 000.

On A’s death, the property will be transferred to the trust but B has a vested interest in the property. When B reaches age 30 and the property is transferred to him, he acquires property valued at R1 500 000. His base cost will however, not be R1 500 000 but rather R1 000 000, being the value of the property at the time he acquired a vested interest in the property.

Even though there is a disposal at the time when the property is transferred to B, it will not trigger capital gains tax as it is disposed of and acquired at the same price, the market value at the time of transfer. When B ultimately sells the property, the base cost will be R1 000 000 and not R1 500 000, so his capital gains liability will be higher.

The trust sells an asset
If having sold the asset, the trust distributes the gain to beneficiaries, the gain will be ignored in the hands of the trust and taxed in the hands of the beneficiary. Should the trust retain the gain instead of distributing it in the tax year the asset was disposed of, the gain will be taxed in the hands of the trust.

An example of a multiple trust structure would be where a share trust has as its beneficiary a family trust and the share trust distributes a capital gain to the family trust. The family trust would then distribute that same capital gain, in the same financial year, to its natural person beneficiaries. In the past, it was common practice for such capital gain to be taxed in the hands of the eventual individual beneficiaries.

The Comprehensive Guide to Capital Gains Tax, SARS makes it clear that this arrangement is no longer accepted. The argument is that when the share trust distributed the gain to the family trust a disposal occurred, the attribution rules should apply to that transaction, and CGT would be payable by the family trust. When the asset is transferred to the individual beneficiary by the family trust, there will be no CGT on the disposal because the base cost will be the same as the proceeds in the family trust.

SARS’ interpretation of the attribution rules was undoubtedly a blow for the multiple trust structure which feeds into one central trust (normally a family trust). The mechanism to move gains from one trust to another and ultimately to natural persons, paying as little CGT as possible, no longer exists. This means that there could be financial shortfalls in the planning of the individuals who will now receive less capital than anticipated. They will need to source additional capital elsewhere, and life insurance may provide the ideal vehicle for doing so.

Disclaimer: Legal or Financial Advice
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