A trust, as a legal concept, differs greatly from a company and a close corporation. A unique set of tax rules also applies to trusts.
A trust as taxpayer
A trust has no separate legal personality like a company or close corporation. However, the Income Tax Act 58 of 1962 includes any trust in its definition of a "person". Income from trust property accrues to the trustees and they are the taxpayer in respect of any income taxable in the hands of the trust. The trustees must ensure the trust is registered with the Revenue Service and make returns of the trust's income.
Previously the undistributed income of trusts was taxed on a sliding scale. Six tax brackets up to a maximum marginal rate of 45 percent were applicable. This year's Budget proposals indicate that the income vesting in a trust will now be taxed at a flat rate of 35 percent on amounts of up to R100 000 and at 45 percent on amounts over R100 000. This does not affect trusts created for people with designated mental or physical disabilities.
Beneficiary as taxpayer
It is not always the trust that is taxed, however. Where the beneficiaries have a vested right to income from the trust, any income earned on trust property will be deemed to be income accrued to the beneficiary and will be taxable in the beneficiary's hands.
But most trusts established for estate planning reasons are discretionary in nature - the beneficiaries have no vested rights to the income or capital. The Act provides that in these circumstances, once the trustee exercises his discretion, the contingent right of a beneficiary becomes a vested one, and the beneficiary is liable for tax. In this way a tax benefit can be achieved by "splitting" the income to various beneficiaries who may be taxpayers at a lower marginal rate.
Trust acts as a conduit
The courts have held that income passing through a trust to a beneficiary retains its identity and the trust acts merely as a conduit through which the income flows. Therefore, if a trust received dividend income and distributed it to a beneficiary, it retains its nature as a dividend and is exempt from tax in the beneficiary's hands.
Distribution of trust losses to beneficiaries
Before the last Budget speech it was possible for beneficiaries to set off, against their other income, losses arising in the trust. The legislation is now to be amended to prevent this. Trusts will no longer be allowed to distribute losses to beneficiaries, but trusts may retain losses and set them off against their income in the following year.
Charitable trusts
It is possible to create trusts which are entirely exempt from income tax. These trusts are created with a view to charity.
The exemption from tax must be obtained from the Commissioner for Inland Revenue.
Whatever type of trust you form, consider the income tax implications, particularly in view of the continuing investigation into the taxation of trusts. The last thing you need is to discover that, while you may have saved estate duty for your heirs, you have created an even bigger income tax problem for yourself.