Are the days of using trusts to reduce tax over?
Adapted from the article ‘Tax reform and financial planning I Section 7C’ in Glacier’s ‘Funds on Friday’ by Jan Vlok, Research and Investment Analyst at Glacier by Sanlam
National Treasury has officially tightened tax provisions on trusts
National Treasury has had intentions to tighten the tax provisions on trusts for many years. On the 1st of March, the new section 7C to the Income Tax Act (ITA) officially came into effect. This will have a significant impact on the broader use of trusts in the industry going forward, particularly for high net worth individuals who use trusts as a financial planning measure.
The new legislation makes it difficult to use trusts to reduce tax
The common use of trusts is to freeze the growth of assets in an individual’s name to reduce estate duty and capital gains tax (CGT). The new legislation, however, makes it increasingly difficult to reduce the tax base in this way.
Let’s consider an example: David has a large share portfolio in his name that he does not need to support him or his family for the foreseeable future. To freeze the growth of the shares in his name, David transfers the shares to a trust. The transaction takes place as a sale to the trust, incurring CGT on the gain made on these shares, payable by David. The table below shows what the tax impact on David would have been before the introduction of section 7C, versus the impact today.
It is important to note that Section 7C applies only to natural persons and companies connected to the trust through a direct or indirect loan, credit or advance made to the trust. Also, donations to trusts falling below the R100 000 threshold will be allowed and will not attract section 7C implications.
Adding actual figures to the example of David’s share portfolio makes the tax impact even more evident:
- Original share portfolio value: R100 000
- Share portfolio value at the time of sale to the trust: R500 000
Make sure you advise your clients timeously on the potential impact on their trusts
Although trusts will still have widespread use as a mechanism to freeze asset growth in one’s name, this will be less than in the past. Nevertheless, trusts still offer various additional benefits, including asset protection from creditors, perpetual lifespan, and protecting beneficiaries from themselves. As a financial adviser, the important thing is to proactively consider the impact of these changes on your clients’ financial affairs to help them mitigate the consequences of the legislation on their long-term financial plan.