Although capital gains tax will negatively affect assets housed in trusts, the tax benefits offered by trusts will still outweigh holding them in your own name. That's the word from tax expert David Clegg.
Don't panic about the introduction of capital gains tax (CGT) - keep your assets in your trust, tax expert David Clegg says.
Speaking at a presentation hosted by BoE Private Bank, Clegg, who is the national director of international tax services at Ernst & Young, says people should move away from paranoia - just make sure your tax structure is robust and you can answer questions from the taxman truthfully.
Different types of trusts are subject to different treatment as far as CGT is concerned. Also, different rules apply to local trusts as opposed to offshore trusts. The tax depends on how a trust is funded.
Clegg says it is fairly simple to change a trust from one type to another if your trust is not the best one in which to house your assets.
Overview
CGT takes effect in on October 1 this year and affects the worldwide assets of South African residents whether they be individuals or companies. Foreign currency profits as well as fixed property or business assets held through trusts are to be included in the CGT net.
When CGT was announced, many people were horrified to hear that it would be charged in addition to estate duty at your death. But, Clegg says, this is not a train smash - it is only a minor derailment.
Assume you have assets of R10 million, with a base cost of R5 million (what your assets were worth when CGT was introduced on October 1). Under the old system, where you just paid estate duty, your estate would have had to fork out R2.25 million to the taxman. Under the new system, where both estate duty and CGT apply, your estate would be liable for only R2.22 million.
If your assets are worth R12 million and the base cost was R3 million, your estate would have had to pay R2.75 million in estate duty. Under the new system, the estate would be liable for R2.956 million.
Where the gains are greater, you will pay more under the new system, but if you don't want to pay the tax, you need to spend more money before you die, Clegg says.
How CGT will affect resident trusts
* Discretionary trusts
Clegg says people are most misinformed about the extent to which CGT will affect discretionary trusts that are set up in South Africa. Discretionary trusts include trusts created by a will and inter vivos trusts (trusts created during your lifetime).
While it is true that individuals will have to pay CGT on any profits they make at a maximum of 10.5 percent and trusts will have to pay 21 percent of any gains to the taxman, there are few instances in which the higher 21 percent rate will be applied in practice, he says.
In general, an inter vivos generation-skipping trust where there is no disposal of assets until the trust is terminated, your estate can achieve substantial savings of estate duty which outweigh the disadvantage of having to pay CGT at the trust's higher rate of 21 percent (which rarely applies).
In the case where you have set up a inter vivos trust for a single generation in which the trust disposes of its assets before it is terminated and the 21 percent rate applies, the situation is only marginally financially worse than if you did not ma{e use of a trust at all. Similarly, where the trust makes multiple disposals of its assets prior to being terminated, the situation is also only slightly worse than if the assets were not housed in a trust.
* Creation of a trust
In a discretionary trust, neither cash donations nor loans to a trust will draw CGT - only if you sell assets to a trust will you have to pay CGT on any profits that you make on the assets. So, if you want to sell an asset to a trust, it is best to wait until the asset has been ordinarily sold and then move the cash into the trust, Clegg says.
* Distribution of assets
When a trust disposes of assets and distributes some or all of the profits, the beneficiary of those gains will have to pay CGT at a maximum rate of 10.5 percent. The amount of CGT you, as beneficiary, will have to pay will depend on your income.
If the trust pays out to a child who has no income, the rate of CGT will be far lower. The exception to the beneficiary being liable for CGT when a trust sells assets and distributes profits, is where profits are given to a minor child and the settlor (the person who originally set up the trust) financed the trust. In this instance, the settlor will be liable for CGT.
* Sale of trust assets
Where a trust disposes of assets but keeps the gains inside the trust, either the funder or the trust will be liable for CGT:
* The funder (the person who originally donated or sold assets to the trust) will pay CGT if he donated assets to the trust or if there is a loan to the trust which has not yet been repaid; or
* The trust will pay CGT at 21 percent if there was no donation and no loan payment to the funder is outstanding. This would typically only happen in a wealthy family where a trust has been in place for many years, probably generations.
* Termination of a trust
Clegg says there is no CGT to be paid when a discretionary trust is terminated and the assets are distributed in cash.
* Usufruct
If you enjoy usufruct of certain assets, you may be under threat from CGT, Clegg says. A usufruct is a right to income from an asset.
While the legislation on CGT concerning usufructs is not clear, it looks as though the impact of CGT on the person who eventually takes full ownership of the asset when the usufruct has expired could be substantial. Clegg hopes that some relief, in the form of amended legislation dealing with this issue, may be forthcoming.
* Trusts and home ownership
If you don't own your home in your name, you won't qualify for the exemption of any profits on the first R1 million that you make when you sell it.
It is better to own your house in your name, but if it is already in the trust's name, you should not transfer it out of the trust just to qualify for the exemption. Rather register your next home in your own name.
While there is a moratorium until March 31 next year on the payment of transfer duty when you transfer a property out of a trust into your own name, Clegg says that, in general, if you do transfer it, you will give away estate duty savings or the possibility of selling a property in a company without the purchaser paying transfer duty (so he can pay you more). The benefits may well be in excess of the saving you can make by claiming the exemption.
The maximum benefit you can get by registering the property in your own name is R105 000 (10.5 percent x R1 million, because the first R1 million profit you make on your house is exempt from CGT).
CGT and offshore trusts
In general, offshore trusts will be untouched by CGT, unless the trusts distribute profits from the sale of assets to a South African resident or if a South African has funded the trust by way of an interest-free loan. The trust itself will not be liable for CGT when assets are sold except if the trust includes property or business assets which are situated in South Africa.
As a South African resident you should not fund your offshore trust by way of an interest-free loan, because then you will have to pay CGT on the profits resulting from any sale of assets by the trust, at a maximum rate of 10.5 percent.
You are liable for CGT even if the trust distributes the profits to a beneficiary who is not a South African resident.
An offshore trust will also have to pay South African income tax on any income except interest from a South African source.
Clegg expects the reporting requirements of the South African Revenue Service regarding assets held or any entitlements in offshore trusts to be tightened up in future.
He does not believe the current CGT laws will interfere any further with offshore trusts.
Record keeping and reporting
If you are registered with the South African Revenue Service as a taxpayer you will have to fill in information concerning capital gains in your normal tax return.
If you are not registered as a taxpayer and you make profits from the sale of assets above a certain threshold - which is still to be announced - you will have to fill in a tax form even if you have no taxable income.
You should keep records for four years after the date of the tax return or five years if you do not submit a tax return.
Clegg warns, however, that you must make sure you keep records of the valuations of your assets, especially if your record system (or that of your tax consultant) is designed to automatically delete records after four or five years.
A new rule of the taxman is that unit trust companies and portfolio managers now have to report the names, identity numbers and transactions of all investors so the authorities can know of your investments, Clegg says.
Valuing assets
There are various methods of valuing your assets. For instance, if you don't get an actual valuation of your assets on October 1, you can use a time-based apportionment calculation, which takes into account the profit made and the length of time you owned the asset prior to October 1.
One method may result in you paying lower CGT than another method, so you have to do your sums, Clegg says. But as a rough rule, if you expect the asset to grow substantially and at an exponential rate over time, it probably isn't necessary to get a valuation.
You don't need a sworn appraiser to value your assets, but it is a good idea to get somebody who has some expertise in the area of the asset to be valued. For instance, you can get a reputable estate agent to value your property or possibly get two valuations and take the average of the two. If you own shares in private companies, you could possibly get an auditor's report.