The establishment of an offshore discretionary trust (“the Trust”) by a South African tax resident person (“Settlor”) gives rise to various South African tax considerations.
In terms of current law (which may or may not be impacted upon by the various proposals set out in the Davis Tax Committee’s First Interim Report on Estate Duty), the following taxes may typically be triggered by the Settlor in respect of the disposal of assets to the Trust in settlement thereof:
- capital gains tax at a maximum effective rate of approximately 13.65% of the capital gain realised;
- donations tax at a rate of 20% of the amount or the market value of the assets donated; and
- any income derived by the Trust in respect of any donation made by the Settlor may be attributed to the Settlor and accordingly subject to South African income tax in his/her hands.
The donations tax and income tax (attribution) implications which may arise in respect of the settlement of assets in a trust may be mitigated by the Settlor settling the Trust with a nominal donation and providing an interest-bearing loan to the trust. As any interest received by or accruing to the Settlor would be subject to South African income tax in his/her hands (subject to a possible tax credit being obtained for any foreign interest withholding taxes suffered), it is ordinarily advisable for the Trust to repay such loan to the Settlor as soon as possible.
In addition to the above, depending on the assets disposed of by the Settlor to the Trust, additional South African taxes may be triggered in this regard – albeit in the hands of the Trust, including:
- securities transfer tax at a rate of, broadly speaking, 0.25% of the market value of any securities transferred to the Trust; and
- transfer duty imposed on a sliding scale based on the market value of any immovable property transferred to the Trust.
Despite the above, South African tax residents pursue the establishment of foreign trusts for a variety of personal and/or commercial reasons, including for purposes of sheltering the assets of the trust from estate duty.
It is very important, however, for Settlors to be extremely cautious when establishing an offshore trust and to obtain the necessary South African legal and tax input in respect of any such trust to be established. Should the Trust be established in such a manner so as to detract from the independence of its trustees and/or provide for the control of the trust assets by the Settlor, the tax implications arising from such trust may differ significantly from the position as set out above.
In determining whether the Trust would be regarded as a trust in terms of South African law, there must, inter alia, be a genuine intention to create a trust. Should this intention be lacking, or if the real intention be to create something other than a trust, no trust will come into existence. In determining whether there was a genuine intention to create a trust (as opposed to a relationship of agency or partnership, for example), a court will have particular regard to the degree of control retained by the Settlor in regard to the affairs of the trust. The Supreme Court of Appeal in Land and Agricultural Bank of SA v Parker and Others 2005 (2) SA 77 (SCA) held that independence of judgment on the part of a trustee is “an indispensable requisite of office” and that, if there is no proper separation of ownership or control from beneficial enjoyment of trust property, the courts may disregard such trust.
Accordingly, should a Settlor be entitled (whether in terms of the applicable trust deed or otherwise) to, for example, appoint and replace the trustees of the Trust, instruct them as to the distribution of the trust capital and/or unilaterally revoke or amend the Trust Deed at will, these powers may be seen as undermining the independence of the trustees, as well as the vital separation between control and enjoyment of the trust property, and perhaps indicating an intention to create a relationship closer to agency than to a true trust.
Whether or not the existence of the Trust is called into question, should the Settlor retain control over the assets of the Trust, such assets may fall within his/her estate for estate duty purposes. In particular, in terms of section 3(3)(d) of the Estate Duty Act No. 45 of 1955, any property which the Settlor would be competent to dispose of immediately prior to his/her death may be subject to estate duty. In this regard, the deceased will be regarded as being competent to dispose of any property if:
- he/she had such power as would have enabled him, if he/she were sui juris, to appropriate or dispose of such property as he/she saw fit whether exercisable by will, power of appointment or in any other manner; or
- if under any deed of donation, settlement, trust or disposition made by him, he/she retained the power to revoke or vary the provisions thereof relating to such property.
Correspondingly, should a Settlor transfer of his/her assets to a trust (as some form of agent for the Settlor), but effectively retain ownership attributes in respect of such assets, such transfer of assets may not constitute a “disposal” for capital gains tax purposes or a donation for donations tax purposes.
It is evident on the basis of the above that a Settlor should have careful regard to the nature of the specific offshore trust to be established as the mere labelling of an entity or an arrangement as a trust does not, in itself, give rise to resultant trust tax and legal implications. It is always necessary to analyse the terms of the applicable founding documentation to obtain certainty in this regard. This is particularly important when applying South African tax and law to foreign "trusts" which are often governed by terms giving rise to different consequences.