In the realm of estate planning, trusts play a crucial role in ensuring the effective management and distribution of assets. Two common types of trusts in South Africa are inter-vivos trusts and testamentary trusts. Both serve distinct purposes and offer unique benefits. This blog aims to shed light on these trusts, exploring their definitions, differences, and key considerations. Trusts are widely used in South Africa for various purposes, including estate planning and wealth preservation. Two common types of trusts in the country are inter-vivos trusts and testamentary trusts. While both serve different purposes, it is crucial to understand their tax implications to make informed decisions when setting up and managing these trusts. In this blog, we will explore the tax considerations associated with inter-vivos and testamentary trusts in South Africa.
An inter-vivos trust, also known as a living trust or a trust created between living persons, is set up during the lifetime of the founder or settlor. This type of trust is governed by the provisions of the Trust Property Control Act of 1988 and serves various purposes, such as asset protection, estate planning, and wealth preservation. Inter-vivos trusts, also known as living trusts, are created during the lifetime of the founder (the person setting up the trust). These trusts are often employed to protect and manage assets, transfer wealth to future generations, or ease philanthropic endeavours. Let’s examine the tax implications associated with inter-vivos trusts:
Inter-vivos trusts are treated as separate taxpayers for income tax purposes. As such, they are subject to the Income Tax Act of South Africa. The trustees of an inter-vivos trust are needed to register the trust with the South African Revenue Service (SARS) and obtain a separate tax number. The trust must file annual income tax returns and pay tax on any income generated by the trust. The applicable tax rates for inter-vivos trusts are generally higher than individual tax rates.
Capital Gains Tax (CGT):
Inter-vivos trusts are liable to pay CGT on the disposal of assets. The trustees must calculate the capital gain or loss when an asset is sold, and this gain is subject to CGT at the trust tax rate. However, inter-vivos trusts are entitled to a rebate, known as the annual exclusion, which exempts a part of the capital gain from tax.
When assets are transferred into an inter-vivos trust, donations tax may be applicable. Donations tax is payable by the donor (the person transferring assets into the trust) at a rate of 20% on the value of the assets exceeding the annual exemption threshold. However, certain transactions, such as donations between spouses or donations to a public benefit organization, may be exempt from donations tax.
Key Features of Inter-Vivos Trusts:
Creation: An inter-vivos trust is created by the founder, who transfers assets (such as property, investments, or cash) into the trust for the benefit of the beneficiaries.
Trustees: The founder appoints one or more trustees to manage the trust assets by the trust deed.
Beneficiaries: The trust deed defines the beneficiaries who will receive the benefits or income generated by the trust assets.
Flexibility: Inter-vivos trusts offer flexibility in terms of managing and distributing assets. The founder can decide the terms, conditions, and timing of distributions to the beneficiaries.
Asset Protection: By placing assets in an inter-vivos trust, the founder can protect them from potential risks, such as creditors, legal claims, or unforeseen financial circumstances.
Tax Implications: Inter-vivos trusts have their own tax implications, and it is advisable to seek professional advice to understand the tax implications specific to each situation.
A testamentary trust, also known as a will, trust, is set up through a will and comes into effect upon the death of the testator. This type of trust allows the testator to distribute assets and support the financial well-being of beneficiaries beyond their lifetime. The Master’s Office, under the jurisdiction of the Department of Justice and Constitutional Development, oversees the administration of testamentary trusts. Testamentary trusts, also referred to as trusts created in a will, are set up upon the death of the testator (the person making the will). These trusts are commonly used to protect and manage assets for the benefit of beneficiaries, especially minors or individuals unable to manage their own affairs. Let’s explore the tax implications of testamentary trusts:
Like inter-vivos trusts, testamentary trusts are separate taxpayers for income tax purposes. The trustees handle registering the trust with SARS, filing annual income tax returns, and paying income tax on trust-generated income. However, testamentary trusts have access to certain tax benefits and concessions, such as the inclusion rate applicable to taxable income.
Capital Gains Tax (CGT):
Testamentary trusts are subject to CGT when disposing of assets. The trustees need to calculate the capital gain or loss on the sale of assets and pay CGT at the trust tax rate. As with inter-vivos trusts, testamentary trusts are entitled to an annual exclusion, reducing the taxable capital gain.
When assets are transferred to a testamentary trust upon the testator’s death, estate duty may be applicable. Estate duty is calculated on the net value of the deceased’s estate and is payable by the estate. However, certain assets left to a surviving spouse or public benefit organizations may qualify for exemptions.
Key Features of Testamentary Trusts:
Creation: A testamentary trust is created through a valid will, whereby the testator includes provisions for the establishment and management of the trust after their death.
Executor and Trustees: The executor named in the will manages administering the estate and implementing the testamentary trust. The executor often appoints trustees to manage the trust assets.
Beneficiaries: The will defines the beneficiaries who will receive the benefits or income generated by the trust assets, and it may include specific instructions for their maintenance, education, or financial support.
Control: Testamentary trusts offer the testator control over the distribution of assets and can be tailored to meet the unique needs of beneficiaries, such as minors, individuals with disabilities, or financially inexperienced individuals.
Estate Planning: By incorporating a testamentary trust in their will, individuals can minimize estate taxes, protect assets, and supply long-term financial security for their loved ones.
Choosing the Right Trust:
When deciding between an inter-vivos trust and a testamentary trust, it is essential to consider factors such as the purpose of the trust, timing, control, and the nature of the assets involved. Seeking professional advice from an attorney or an estate planning expert is highly recommended to ensure that the chosen trust aligns with specific goals and meets legal requirements.
Inter-vivos trusts and testamentary trusts serve distinct purposes within the realm of estate planning in South Africa. Inter-vivos trusts are set up during the founder’s lifetime and offer asset protection, wealth preservation, and flexibility in managing and distributing assets. Understanding the tax implications of these trusts is essential for effective wealth preservation.