James Coutinho, Head of Tax at Liberty, looks at how the budget affects your financial planning
The increase in the top tax rate as highlighted in the 2017 Budget Speech means that trusts will pay 45% tax on income (interest, rental income). The effective capital gains tax (CGT) rate increased from 32,8% to 36%. As a result, it is going to be much harder for you to earn the desired returns on direct investments.
Attempts to lessen the tax implication can lead to more complexity. If, for example, an investment you hold in a trust is switched from one unit trust fund to another, you could be liable to pay CGT. To lessen the tax impact the gain is passed to the beneficiary who, in turn, lends the amount back to the trust. This has all sorts of unintended consequences, such as exposure to creditors, increases in the individual’s estate for estate duty purposes, and could be seen as a taxable event under section 7C of the Income Tax Act.
What Section 7C means to you
Section 7C came into force on 1 March 2017, which means that any low interest loans to trusts will be deemed as a donation taxed at 20%. The 2017 Budget Review aimed to close the loophole of some smart trust planners who were using a company to issue the loan and thereby having the trust owe an “unconnected” company the loan.
The impact of section 7C is potentially far reaching. At the very least, if you have a trust, you should be re-looking at your trust deeds. It is important to consider whether there are any “undistributed” distributions where the trust makes the distribution for tax purposes, but does not actually pay the benefit across – most beneficiaries will not realise that this could in fact be an affected loan account.
Remember that certain trusts such as special trusts and certain loan arrangements, including those for the purchase of a primary residence, will be excluded from section 7C.
Those people who hold loan accounts in trusts and are affected will have to consider whether they should:
- Charge interest on the loan and, if so, how the trust will pay this interest
- Actually donate the loan account and pay the donations tax
- Write off the loan account and consider any adverse tax consequences
- Wind up and deregister the trust completely
- Pay the donations tax annually
It is a good idea to source advice from a tax and trust professional and always remember the original objectives. What was the real, bottom line decision for establishing the trust in the first place?
Consider an endowment to lessen the tax impact
When it comes to market-related investments, you may want to consider holding investments in an endowment structure as it carries a lower rate of tax. If the beneficiaries of the trust are natural persons, then the endowment will be taxed in the Individual Policyholder fund at 30% for interest and rental income, 12% for capital gains tax and 20% for dividend withholding tax.
An endowment can also simplify the administration as there is no disposal on a portfolio switch and after five years one does not have any restrictions on the policy proceeds from the endowment. In addition, as the returns on the endowment will already have been taxed, and provided the trust is the original owner of the endowment, the trust will not be subject to tax on the policy proceeds. |
