Unpacking the taxation of trusts

The taxation of trusts has been a grey area for some time. The proposed changes in legislation was published for comment recently. We now have a better idea of what’s potentially on the cards. Government’s intention is to limit the ability of taxpayers to transfer wealth from one generation to the next without being subject to tax.

The key point of the Draft Taxation Laws Amendment Bill (TLAB) is the issue of interest-free loans. Interest-free loans to trusts will not be liable for donations tax and will help to lessen the burden of estate duty, as is currently the case. However, these donations will be liable for income tax in the future. This will also apply to loans with interest rates set below an accepted market rate (currently 8%).

The new legislation, if passed, will be applicable to any new loan made to a trust, as well as any existing loans already in place.

Tony Barrett writes in his blog “A testing time for trusts” that existing trust structures with loan agreements will have to be examined to find a suitable strategy for the future:

  1. Charge an 8% p.a. market related interest on the loan accounts. This results in taxable interest income accruing to the lender, and more often than not, no equivalent tax deduction in the trust.
  2. The lender pays 20% donations tax and donates the loan to the trust, thereby doing away with the loan.
  3. The trust repays the loan to the lender. This course of action may result in a hefty CGT charge for the trust as it realizes assets to repay the loan.
  4. The anticipated new legislation is adopted and deemed interest is taxable in the hands of the lender.

There are still uncertainties regarding the practical implementation of the bill. A consultation process is now in place. If this Taxation Laws Amendment Bill (TLAB) is passed, it will be effective from 1 March 2017. The best thing to do is to seek professional tax advice early, and certainly well in advance of the new tax year.

 

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