The Income Tax Act (ITA) provides for the creation of so-called special trusts, where the trust is created for the benefit of a person who cannot take care of his or her own affairs because of a disability, including a serious mental illness. The trustees of such a trust must administer the assets of the trust in favour of the beneficiary.
For a trust to become a special trust, it must register as such with the South African Revenue Service (Sars).
The benefit of the special trust dispensation is that, in some respects, special trusts are taxed in similar ways as individual taxpayers, not as ordinary trusts. For example, the income that accrues to or is received by a special trust during a year of assessment is calculated according to the tax tables applicable to individuals. A special trust is not taxed on income at the rate of 45%, as are ordinary trusts. It also pays capital gains tax (CGT) on disposals at the same rate as individuals, where the maximum effective rate is 18%.
Louis Botha, a senior associate in the tax and exchange control practice at Cliffe Dekker Hofmeyr, provides the following commentary on Binding Private Ruling 384. This ruling dealt with a matter where a question arose about the donations tax and CGT consequences resulting from the beneficiary of a special trust ceding his loan account against the trust to that trust.
Background
The applicant suffered a traumatic brain injury that left him unable to work, talk, or maintain himself independently, but he was still able to make decisions. His wife took care of his physical needs and managed his financial affairs under power of attorney.
The co-applicant was a special trust for the sole benefit and maintenance of the applicant for the rest of his life. The secondary beneficiaries of the special trust were the applicant’s spouse and children, who could only benefit as discretionary beneficiaries from the trust after the applicant’s death.
The special trust formerly served as a family trust for the benefit of the applicant, his spouse, and children. It became a special trust after the trust deed was amended.
The applicant had a loan account against the special trust because of funds made available to the co-applicant. The applicant proposed ceding this loan account to the special trust with the objective of reducing the trust’s liabilities and ensuring that more funds were available to take care of the applicant’s maintenance needs during his lifetime if something happened to his wife.
The ruling
Botha says it is important to note that Sars’s ruling was subject to the additional condition and assumption that the cession of the loan account did not result in an amount being transferred to the special trust that was excessive for the purposes of the applicant’s maintenance.
Pursuant to this, Sars ruled as follows:
- The cession by the applicant of his loan account to the special trust did not constitute a donation in terms of section 54 of the ITA.
- The proceeds in respect of the cession of the loan account would be equal to the face value of the loan account, under paragraph 38 of the Eighth Schedule to the ITA. Consequently, no capital gain or loss would be realised by the applicant from the cession of the loan account, and paragraph 39 did not apply.
Analysis
Botha says Sars’s finding that the cession of the loan account did not constitute a donation was unsurprising. In BPR 306, the facts were similar, and Sars ruled that where the primary beneficiary (who suffered from early onset dementia) intended to transfer an amount to a special trust to provide for her future upkeep and well-being, it did not constitute a donation in terms of section 54 of the ITA.
“It is possible that Sars’s view in the case of BPR 384 was also that the cession of the loan account was not motivated by ‘pure liberality or disinterested benevolence’ (the key requirement for a donation in addition to the definition in section 54 of the ITA), as the cession will only benefit the applicant during his lifetime,” Botha says.
“It is also possible that the condition to which the ruling was subject, that the cession of the loan account does not result in the transfer of an amount that is excessive for purposes of the applicant’s maintenance, played a role in Sars’s decision.”
Regarding CGT, Botha says Sars’s ruling on the application of paragraphs 38 and 39 of the Eighth Schedule of the ITA was sensible. “These paragraphs were likely considered, as the applicant, being a beneficiary of the special trust, is a connected person in relation to the trust.”
He says the purpose of these provisions is to prevent tax avoidance where assets are disposed of in the context of connected persons, by stating that disposals between connected persons:
- are deemed to take place for an arm’s length consideration (if the consideration is less than an arm’s length price); and
- resulting in a capital loss, must be treated so that the capital loss is ring-fenced and can only be set-off against capital gains realised because of disposals between the same connected persons.
Given that the consideration for the asset, the applicant’s loan account against the trust, was equal to the face value of the loan, no capital gain or loss arose because of the cession.
Disclaimer: The information in this article is for general purposes only and does not constitute legal or tax advice that is appropriate to every individual’s needs and circumstances. The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies.
