Trusts Notes - Summary Taxation III PDF

lOMoARcPSD|12137904 Trusts Notes - Summary Taxation III Taxation III (University of Cape Town) Scan to open on Studocu Studocu is not sponsored or endorsed by any college or university Downloaded by KHANYISA MAKHOSI ([email protected]) ...

lOMoARcPSD|12137904 Trusts Notes - Summary Taxation III Taxation III (University of Cape Town) Scan to open on Studocu Studocu is not sponsored or endorsed by any college or university Downloaded by KHANYISA MAKHOSI ([email protected])  lOMoARcPSD|12137904 TRUSTS- TAX III PURPOSE OF TRUSTS?  Income splitting  For your family- bene昀椀ciaries  For estate planning purposes  To Freeze the value of the asset.  Protect your assets (when they are in the trust they are not in your name)  As a trading vehicle  Also for charitable purposes The accumulation of value of the asset goes to the trust. HOW DO TRUSTS COME ABOUT? Trust deed or Will of the Deceased Trustees  They help run the trust.  They look after the assets of the trust.  They are the custodians of assets in their 昀椀duciary duty. A trustee can be a bene昀椀ciary but cannot be the only Trustee. CREATOR OF A TRUST  Donor  Founder  Deceased TYPES OF TRUSTS  Intervivos trust- created when the founder is still alive.  Testamentary Trust- created through the will of the deceased. Vesting Trust (Automatically) Vests income to bene昀椀ciaries immediately the income is earned. Property that is vested- it means you have a right to that income. To vest income it does not mean the money has been transferred. Payment is actually made when the income is distributed. Non-Vesting Trusts- Discretionary Trust Income is vested at the Discretionary of Trustees. Trusts can have elements of both vesting and non-vesting. How do trusts come into existence? Trust deed needs to be registered at the Master’s O昀케ce. A trust is not a separate legal entity. Trusts are seen as persons in the income tax act. HOW TO GET ASSETS INTO A TRUST Downloaded by KHANYISA MAKHOSI ([email protected])  lOMoARcPSD|12137904  The assets can be donated to the trust by the donor.  Sold into the trust by the Founder. Those assets can be sold at any value. Commonly sold at market value. If the sale is less than market value then there is a donation element.  Loan account is created- Trusts do not have money to buy the asset. The loan can be interest bearing or interest free. Or they can be 昀椀nanced externally. TAX RATES FOR TRUSTS A 昀氀at rate of 45%. Inclusion rate CGT=80%. Special trusts- are taxed based on the individuals sliding scale. Types of special trusts- For people who cannot look after themselves. Or a will for minor children. They are not entitled to rebates and natural persons exemptions. S25B- How to tax trusts. Section 7 superceeds S25B S7(1)- Income is deemed to accrue to a person even if it isn’t paid. TAXATION OF MARRIED PERSONS Married persons are taxed separately on their income unless S7(2) applies, which deems one spouse’s income to have accrued to the other spouse. S7(2)- Anti-avoidance This section applies to any income received by or accrued to any person(recipient); such income is deemed to be the income of such person’s spouse (the donor) in one of the two situations:  The income was derived in consequence of a donation made by the donor(spouse), the sole or main purpose of was to reduce the donor’s liability of any tax. OR  The income was derived by reason of a transaction, operation or scheme carried out by donor(spouse), the sole or main purpose was to reduce, postpone or avoid the donor’s liability of tax. 2.  The income was derived from any trade carried on by recipient in partnership with their spouse or which is connected with the trade of spouse. OR  The income was derived from spouse; or from a partnership in which the spouse is a member; or from a private company in which the spouse is a sole or main or one of the principal shareholders. AND Such income exceeds an amount that the recipient may reasonably be expected to earn, having regard to nature of the trade, the extent of the recipient's participation or any other relevant factor. NOTES Downloaded by KHANYISA MAKHOSI ([email protected])  lOMoARcPSD|12137904 COMMUNITY OF PROPERTY- S7(2A), S7(2B), S7(2C) Spouses married in community of property are taxed equally on their investment income(interest, dividends and rental income) because they own the assets jointly. The general principle is therefore that investment income accrues equally to each spouse as they own the underlying property jointly. Trade income accrues to the spouse who earns it. S7(2A) If the marriage is a community of property marriage: Income earned by any spouse in carrying on a trade is deemed to be the income of that spouse; or Income earned from a trade carried on by both spouses accrues to each spouse in the proportion determined by the terms of the agreement which regulates the trade. If there is no agreement then the income is split according to the amount each spouse is entitled to having regard to the trade, extent of participation and the services rendered. The split is subject to the provisions of S7(2)(b)- anti- avoidance section. Income derived from the letting of 昀椀xed property or any income derived otherwise from carrying on a trade is deemed to accrue in equal shares to each spouse, with the proviso that income which does not fall legally into the joint estate of the spouses is deemed to the income of the spouse who is entitled to it. S7(2B) Deems any allowable deduction or allowance which relates to income deemed to be a spouse’s to be deductible in that spouse’s hands. S7(2C) Amounts paid or payable to a spouse in his or her capacity as a member or past member of a:  Pension fund or pension preservation fund  Provident fund or provident preservation fund  Bene昀椀t fund  Retirement annuity fund  Any fund of a similar nature Are deemed to the income of that spouse. (S7(2C)(a) An annuity which is an annuity for the purposes of S10A (purchased annuities) is deemed to be the income of the spouse who is entitled to it. TAXATION OF MINOR CHILDREN Minor children are taxed in their own name on income which is received or accrues to them unless section 7 applies which deems the income to the income of the parent. When the income arises by reason of a donation by the parent to the child(directly or indirectly) the income is taxed in the parent’s hands and not in the child’s hands. Downloaded by KHANYISA MAKHOSI ([email protected])  lOMoARcPSD|12137904 S7(3) If a parent made a donation or other similar disposition to their minor child which resulted in:  The minor child receiving income or  Income accruing in favour of the child or  Income being expended for the maintenance, education or bene昀椀t of that minor child or  Income accumulated for the bene昀椀t of that child. Such income will be deemed to be the income of the parent that made the donation. The donation must be gratuitous. S7(4) The income of a minor child is deemed to be the parent’s income if the parent makes a donation to some other person or that person’s family in return for a donation to be made to their minor child. Then the income from that donation will be deemed to be that of the parent. NOTES The reference to income in S7(1) to S7(7) is income in the economic sense and not income as de昀椀ned. Simpsons case- does not matter if the income is exempt for the purposes of S7(1)-7(8). S7(3) AND S7(4) applies to income received by stepchildren as well. De昀椀nition of a child also includes adopted children. Grandchildren are excluded. It is not the donation amount itself that is included in the parent’s income (e.g. value of donated shares) but the income resulting from the donation (dividends generated by the shares. S7(5) If you make a donation to a trust that is subject to a future event happening. The income is deemed to be the income of the donor if the future event has not happened. Income that is left in the trust goes back to the donor. Taxing goes with the vesting. The income of a discretionary trust which arises in consequence of a donation will always be taxed in the donor’s hands unless it is distributed to bene昀椀ciaries. Such income will only be taxed in the trust once the donor has died. S25B- INCOME OF TRUSTS Is the principal taxing section relating to trusts. Subject to S7 the income of the trust is taxed either in the hands of the trust or in the hands of the bene昀椀ciaries. This section does not apply to amounts of a capital nature that are received by or accrue to a trust nor to amounts accruing to a trust from a retirement fund. If S7 applies that other person may be taxed instead of the trust. S25B (1) Downloaded by KHANYISA MAKHOSI ([email protected])  lOMoARcPSD|12137904 Any amount received by or accrued to or in favour of any person, in his or her own capacity as a trustee of a trust- during any year of assessment shall, subject to section 7 To the extent that it has been derived for the immediate or future bene昀椀t of an ascertained bene昀椀ciary (named bene昀椀ciary) who has a vested right to such amount during such year be deemed to be an amount which has accrued to the bene昀椀ciary. Otherwise, be deemed to be an amount which has accrued to the trust. vested rights – income of bene昀椀ciary. No vested rights – income of the trust S25B (2) Where the bene昀椀ciary has acquired a vested right to any amount in consequence of the exercise by the trustee of a discretion vested in him by the trust deed, such amount is deemed to be derived for the bene昀椀t of that bene昀椀ciary. Trustees exercise discretion: vest income in a bene昀椀ciary (during the year the income is earned) it is taxed in the hands of the bene昀椀ciary (subject to s7). S25B (3)- Deductions and allowances follow income. S25B (4)- LIMITATIONS Any deduction or allowance referred in S25B(3), allocated to a bene昀椀ciary shall be limited to the income accruing to the bene昀椀ciary from that trust in the year of assessment. S25B (5) The excess of expenditure over income in S25B(4) shall be deducted by the trust in that year but limited to the taxable income of the trust before the deduction of such expenditure. Where the trust is not subject to tax in South Africa, the excess expenditure is carried forward and treated as a deduction or allowance the bene昀椀ciary may claim in the next year from the income she gets from that trust. S25B (6) If the trust cannot absorb the full deduction or allowance disallowed to the bene昀椀ciary (S25B(4) & (5)) The excess may be granted as a deduction or allowance to the bene昀椀ciary in the next year of assessment subject to the same limitations in S25B(4). The deduction is limited to the income accruing to the bene昀椀ciary in from that trust in the year of assessment. S25B (7) s25B (7)-(4) to (6) Don’t apply if the bene昀椀ciary is not subject to tax in SA (i.e. excess deduction is lost – cannot revert to the trust). Assessed loss of a trust cannot be distributed. Downloaded by KHANYISA MAKHOSI ([email protected])  lOMoARcPSD|12137904 Conduit pipe principle What is a “conduit pipe”? Armstrong case – Income in a trust retains its identity. E.g. interest income in a trust distributed to bene昀椀ciary (during the year of receipt or accrual) – the bene昀椀ciary is entitled to the interest exemption against that interest. Same for dividends. Annuities out of the income of the trust: s10(2)(b) still applicable S10(2)(b)- the said exemptions shall not apply in respect of a portion of annuity. S10(1)(h)- any amount which is received by a non-resident (is exempt) unless that person is a natural person present in the republic for a period more than 183 days in aggregate during the 12 months period preceding the date interest was received. S10(1)(k) Dividends So, if the annuity is paid out of income that constitute dividend income and interest income those portions of the annuity will not be subject to the exemptions in S10. If capital paid out: para (a) of gross income de昀椀nition overrides capital nature Woulidge- S7C Anti-avoidance provision Method to limit attribution. Markert related interest applies to woulidge If a natural person makes a loan to a trust to which he or she is connected to, a donation will arise if the interest on the loan is less than the o昀케cial rate of interest. It applies to any loan, advance or credit provided by a South African Resident individual. The aim of S7C is to prevent the estate duty avoidance that could result when a person transfers a growth asset to a trust in return for a 昀椀xed loan that does not grow in value, because no interest is charged on the loan. This also applies when the natural person makes an interest-free loan or low interest loan to a company held by a trust, or a company makes a loan at the instance of a natural person to a trust or company held by a trust. Where a company makes a loan at the instance of a natural person, S7C would treat the non-charging of interest as a donation by the natural person(Deemed Donations). The amount of the donation is calculated as follows: Amount of loan x (interest at o昀케cial rate – minus actual interest charged) = donation This calculation is done each year based on the tax year of the trust. The donation for the year(after deducting any exemption) is subject to donations tax. Downloaded by KHANYISA MAKHOSI ([email protected])  lOMoARcPSD|12137904 And this calculation is done every year for as long as the loan is outstanding. (the interest on the loan is calculated based on the number of days). Section 7C was amended to state that if loans are made to a company in which the trust or a bene昀椀ciary of the trust held at least 20% of the equity shares, then the provisions of the section still applied. S7C (2) states that no deduction, loss, allowance, or capital loss may be claimed in respect of a loss made by the lender on a (low-interest or interest-free) loan to a trust, or on the disposal of the loan by the lender. Therefore, if the trust cannot repay the loan and the lender waives the loan or a portion of it, he or she may not claim a capital loss on the waiver even if the trust has a corresponding tax e昀昀ect, such as a reduction of its assessed losses on loans. No imputed interest. Note that if the loan is reduced by means of a voluntary waiver by the lender, this would constitute a donation of the loan in favour of the borrower. Paragraph 12A(6)(b)(i) of the Eighth Schedule excludes a donation from the operation of paragraph 12A as a whole, if donations tax has been paid on the donation. This means that the trust in this case will not have to reduce the base cost of any capital asset that the loan funded. S7C (3) S7C(1)(b)- states that the section also applies where certain companies make loans to a trust (or to a company owned by a trust) at the instance of a natural person. This requires that the natural person hold at least 20% of the voting rights or equity shares in the company. This holding can be direct or indirect. The requirement is also satis昀椀ed if the natural person holds less than 20% of the equity shares or voting rights, but the holdings of persons connected to him or her bring the total to 20% or more. If the natural person holds no shares in the company, but a connected person does, the connected person rule does not apply to that natural person. Interest free portion(< o昀케cial rate of interest) deemed to be a donation S7C (4) states that if a loan, advance or credit is provided to a trust by a company, at the instance of more than one person connected to the company, then the donation is deemed to be made by the persons in the ratio of their equity shares or votes in the company to each other. S7C (5)- Exclusions Loan to PBO Downloaded by KHANYISA MAKHOSI ([email protected])  lOMoARcPSD|12137904 Loan for fully vested rights to receipts, accruals and assets Special trusts S7(1B)- preference shares(de昀椀ned in S8EA(1) Dividends are deemed to be interest on the deemed loan. Dividends reduce the deemed donation for 7C. FOREIGN INCOME- S25B(2A) Accumulated income (i.e. capital) of a foreign trust - distributed to a South African resident - who was a bene昀椀ciary in the (previous) year when the trust received the amount - shall be included in the income of the South African resident - if it has not already been subject to tax in South Africa (for example, under section 7(8)) - provided that such amount would have been income of the trust if it had been a South African resident at the time the amount accrued to the trust. If provisions of this section are met then the capital must be seen as income. S7(8) This deals with amounts which are received by or accrued to non-residents, as a result of a gratuitous disposition by a resident. Non-resident receive an amount that would have been income if they were an SA resident. ( the income is not exempt. By consequence or by reason of a donation or settlement or disposition made by a SA resident. The amount is included in the income of the SA resident donor. Also subject to Woulidge S7C. The non-resident could be the trust and the income is retained in the trust. The non-resident could be a bene昀椀ciary. If the donor has passed away then no attribution can happen. 7(8), 7(5) does not apply. Then the income in the non-resident hands determine the source of income, if SA source then the income will be taxed in the non-resident’s hands. When a trust makes a donation there is no donations tax s56(l) exemption. CGT Downloaded by KHANYISA MAKHOSI ([email protected])  lOMoARcPSD|12137904 Para11(1) of the 8th Schedule- disposals Vesting of an interest in an asset of a trust in a bene昀椀ciary The decrease Assets ? donated to trust, sold on interest free loan account when tust was founded. Income earned used to purchase other assets, Cgt arises when- trust sell the asset and vest the proceeds in the bene昀椀ciary. Trust decide to send asset in the bene昀椀ciary (vests to bene昀椀ciary) Para80- capital gains- how trusts are taxed on those capital gains 80(1)- asset vested in resident bene昀椀ciary which means the bene昀椀ciary has the right to the asset. Ownership has transferred. (also applies to the distribution) Then the gain on that asset will be taxed on the bene昀椀ciary’s hands. The gain Goes along with the right to the asset. Bene昀椀ciary acquired right to an asset, have an asset with a base cost of an amount equal to market value at date the asset vested to bene昀椀ciary. (Disposal to connected persons- para38) TRUST SELLS THE ASSET FIRST Trust sells asset to a 3rd party, then proceeds vest to the bene昀椀ciary. The tax e昀昀ects are the same as above, bene昀椀ciary taxed on the gain. Gain taxed on bene昀椀ciary’s hands. NON-RESIDENT BENEFICIARY If there is no attribution to the donor, the capital gain arises. The trust will be taxed on the vesting of the gain or asset. The trust will be taxed (where para 72 attribution does not apply) Para72- similar to s7(8) Thereafter no sa tax implications. Non-resident trusts- para83 Foreign trust, capital gains from prior years. vested in resident bene昀椀ciary If the trust had been resident, would they be taxed on the amount ? Bene昀椀ciary when the capital was earned that bene昀椀ciary was a bene昀椀cary of the trust Gain must not have been taxed in SA. Then the bene昀椀ciary will have that capital included with their other capital gains and losses LT EX 3 CG of D PROCEEDS – MV Downloaded by KHANYISA MAKHOSI ([email protected])  lOMoARcPSD|12137904 Base cost- para20 Annual exclusion because bene昀椀ciary is a natural person Gain taxed on D’S hands. Base cost can equal to mv, where donor donates an asset to trust then the base cost will be mv at date of donation Trust sells the asset to 3rd party Proceeds 3m Base cost 1m Gain 2m D receives 3m the proceeds but will be taxed on the 2m the capital gain. Less 40000 annual exclusion = taxable capital gain. Spouses and parents attribution- Para68(1)- similar to s7(2)(a) LT EX5 Para70- capital gain left over in trust end of yoa , attributed back to donor- similar to 7(5) Downloaded by KHANYISA MAKHOSI ([email protected])