The use of properly structured, well-managed Trusts provides for a legal separation between an individual’s personal wealth and the wealth he or she jointly controls in a particular Trust. This legal separation affords an individual or family a lot of advantages related to protecting their hard-earned wealth, such as reduced tax erosion on death and reduced exposure to losses through litigation. For the above reasons, and many more, well informed property investors and businessmen make extensive use of Trust structures.
In depth knowledge of Trusts though opens up other advantages of using a Trust, which include the use of the so-called ‘Conduit Principle’. The Conduit-Principle relates to Tax Law that allows for a unique way of applying Income Tax to Taxable Income generated in a Trust, whereby such Taxable Income can taxed in the Trust, or in the hands of the Beneficiaries – the ability to choose is subject to a myriad of anti-avoidance provisions in Tax Law, therefore only the most experienced Trust Specialists can take advantage of this effectively. The tax advantage of having the option to choose where income is taxed, lies in the differences between the tax rates applicable to Trusts (40%) compared to tax rates applicable to individuals (0 – 41%). Individuals also enjoy several tax exemptions and exclusions, which a Trust would not and therefore having the option to have income taxed in the individual’s capacity, quite often is more favorable than having it taxed in the Trust where the income originated.
Understanding and applying the Conduit-Principle is a specialist field, and if applied correctly, can result in an extremely tax-efficient structure. Unfortunately, with the general insatiable desire to reduce taxation, many taxpayers and tax advisors alike have veered from the true purpose of Trusts (see first paragraph) and blindly pursue the Conduit-Principle as the sole or primary reason for using Trusts. This trend has continued for many years, and has resulted in gross abuse of the Conduit-Principle which has unfortunately aroused the interest of the tax authorities. Simply put, the tax authorities continuously seek to limit losses in tax revenue for obvious reasons, and where a system or structure used by taxpayers undermines this objective, it is inevitable that the tax authorities will seek ways to either limit or eliminate such systems/structures. In this light, the Conduit-Principle has been brought into the limelight several times in the past, and now, more than ever, the threat to eliminate the Conduit-Principle seems real and imminent.
In Mid-2013, under a directive implemented by Mr Pravin Gordhan, the Davis Tax Committee (‘DTC’) was created to assess various components of the current tax framework, which included the manner in which tax was calculated in Trusts (with specific reference to the Conduit-Principle). Recommendations by the DTC ultimately included the revision or complete abolishment of the Conduit-Principle. The initial report from the DTC toward the end of 2014 stated that a change in the Conduit-Principle would result in a huge impact, and therefore any intended changes would have to be announced in the 2015 Budget Speech, and would only be effective from the following tax year. The 2015 Budget Speech included many references and changes based on the DTC recommendations, but interestingly, no reference or changes were made to the Conduit Principle. However, the Conduit Principle abuse continues, SARS continues to lose revenue, and therefore change will be coming soon.
Understanding and applying the Conduit-Principle is a specialist field, and if applied correctly, can result in an extremely tax-efficient structure.
Well-informed advisors consider the impact of such changes, and therefore it should be noted that if the Conduit Principle is completely abolished, the end result would be as follows:
• In terms of using Trusts to reduce Estate Duty, Capital Gains Tax, Executors Fees and other related costs upon death – this would remain intact (unaffected)
• In terms of using Trusts to provide for a virtually seamless transition of wealth upon death to the next generation by avoiding frozen Estate issues and bureaucratic delays – this would remain intact (unaffected)
• In terms of using Trusts to reduce exposure to asset loss through litigation/divorce and so on – this would remain intact (unaffected)
• In terms of using Trusts to reduce Income Tax using the ‘Conduit Principle’ – this would not be possible any longer, but there are several other methods that can be used to reduce Income Tax. Essentially, for Specialist Trust Advisors, eliminating the Conduit-Principle will only frustrate the ability to reduce taxation in a Trust, not eliminate it.
For those who setup Trusts with the sole purpose to avoid tax using the Conduit Principle, the abolishment thereof would result in an extremely frustrating tax situation and possibly an obsolete structure. But, for those who created Trusts to protect their hard-earned wealth, the Trusts remain the ideal tool to achieve effective Risk (Exposure) Management and Estate Planning.
By Michael Dryden