In 1991 legislation was introduced that determined how the income of vesting trusts was to be treated. The following year the legislation was clarified insofar as the deductions of expenditure of such trusts was concerned. This year a change has been made that reverses, to a degree, the 1992 provisions because, as Finance Minister, Trevor Manuel advised in his budget speech, people were using the provisions to their advantage!
So what do the changes mean to you?
To understand the effect of the changes it is important to understand the concept of a vesting trust vs a discretionary trust.
If you are a beneficiary of a trust which gives you vested rights, the trust deed will define the proportion of the income and/or capital to which you are entitled. Although the trustees may determine when that income or capital is paid to you, they may not change your entitlement. You will also be able to determine what happens to the funds to which you have a vested right after your death and bequeath them in your will.
If you are a beneficiary of a discretionary trust, that is one in which you do not have vested rights, the trustees will have the discretion to decide when and how much of the trust funds to give you.
On your death, the trust deed will either specify what is to happen to the remaining funds or the trustees will be left to decide. You, as the beneficiary will not have any control.
Put simply, the tax laws have, up to now, required that for a vested trust, the income and expenditure relating to a beneficiary will not be taxed in the trust. Instead the income will be taxed in the beneficiary's hands.
In addition, the related expenditure was to be deducted in the beneficiary's hands.
If you were the beneficiary with vested rights to specific income, and the related expenditure and allowances were more than that income, you would be able to reflect a loss, which would be deductible against your other income, for example, your salary, on your tax return.
This made trusts a popular vehicle for trading activities. The advantages of using a trust as against a company or partnership were:
* The loss in a company, which gives you as a shareholder limited liability benefits, is stuck in the company and can't be used by you, as the shareholder; and
* Although as a partner, the loss of a partnership may be set off against your other income, the partnership does not provide you with any limited liability benefits.
To counter this the law is being changed so that, for trusts formed after March 11, 1998 from the 1999 tax year, and for existing trusts from the 2000 tax year, any expenditure relating to trust income which accrues to you, as a beneficiary with vested rights to that income, will be limited to that income. If the expenses are more than the income you will not reflect a net loss in your tax return. You will claim expenses equal to the income.
The balance of the expenses may be claimed against any balance of income remaining in the trust. If there are still expenses which have not been offset against income, they may be carried forward to the following year and set off against income less expenditure vested in you from the trust in that year. If there is none, it will be set off against income remaining in the trust in that year. Failing that, it will be set off against trust income received or accrued to you or the trust in the succeeding years.
The consequence of the change is, not that the expenditure will never be claimed as a deduction, but that it can only be claimed against income generated by the trust. It can't be claimed against income received or accrued by you, the beneficiary, from other sources.