Trusts and Taxes - How to Ensure Your Investments are Efficient

It’s crucial to be as tax efficient as possible, especially when making big decisions on how to invest via a trust. We take you through some of the important things to consider.

Glen Wattrus CFP®

Glen Wattrus CFP®

Private Wealth Manager

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Trusts and Taxes - How to Ensure Your Investments are Efficient

I am often asked by my clients about the most tax efficient way to build up assets in offshore trusts. There are two main considerations: should they use asset swaps or their R10 million annual offshore allowance? What is the best way to put money into the trust: as a donation or a loan?

Asset swap or offshore allowance?

A South African-based trust is not allowed to invest directly offshore but may do so by way of an asset swap. The downside of an asset swap mechanism is that the assets never actually leave the country and will always pay out in South Africa if the investment is liquidated. The trust would benefit from capital growth and any rand depreciation against hard currencies.

But the end result of a rand payout doesn’t meet with the long-term objective of having the funds invested OUTSIDE our borders if, for example, you are planning to financially emigrate. In this case, it may be advisable to use your annual offshore allowance of R11 million (for which SARS clearance must be obtained for R10 million; the first R1 million can be taken out of the country with no tax clearance).

Whichever option suits the client’s individual circumstances, the next question is whether to donate or lend this money to the trust, whether onshore or offshore. Both options have important tax implications.

Donate versus loan?

A donation will attract a 20% donations tax so you must be comfortable with the upfront pain of seeing 20% shaved off your capital.

On the other hand, lending the money is a fairly complicated process that involves accounting expenses and annual reconciliations as to interest generated. Such a loan will also be subject to Section 7C of the Income Tax Act, which came into effect on 1 March 2017. It stipulates that qualifying loans issued by related parties to a trust must be taxed. Effectively this means that any loans made at a rate lower than the official rate of interest (currently 7.75%) attract a 20% tax as a deemed donation for the difference between the two applicable rates and after taking a taxpayer’s R100 000 per annum donation allowance into account.

While a donation is a more straightforward process than a loan, it can be challenging to stomach losing a massive slice of your pie upfront. Setting aside the emotional involvement is advisable though, even in these extremely trying market conditions; relying instead on what the numbers say will help you make a more informed, objective decision.

Crunching the numbers

As we all know, investments never follow set returns unless in a fixed interest guaranteed investment. There is unfortunately no other way than to make assumptions based upon returns being the same for both options. For ease of this exercise we will also assume straight line returns.

Let us say the client has R10 million to invest in a trust. We make the following assumptions:

  • Annual returns in both examples are 8% per annum
  • Donations tax is 20%
  • In the loan example we assume no interest charged on the loan
  • Client passes away at end of 20 years, so the outstanding portion of the loan this point attracts 20% estate duty

Example 1 (loan to the trust for 20 years)

Balance of R10 million loan:                         R  8 000 000

Capital value of investment:                       R42 300 612

Deemed donation for 20 years:                  R14 647 500

Tax on deemed donation:                            R  2 929 500

Estate duty on outstanding loan:               R  1 600 000


Example 2 (painful upfront donations tax)


Initial investment:                                           R  8 000 000

Capital value of investment:                       R41 042 892


Example 1 has a modestly better end result by R1 257 720 BUT estate duty of R1 600 000 on the outstanding loan has a nett result of -R341 280.

The process and assumptions are a simplified example but one can see that over a 20 year span, it would appear to be better to take the pain upfront. This will also remove the need for mountains of paperwork during the course of the investment.

This can be applied to both local and offshore trusts. In the case of an offshore investment, please ensure that SARS is made aware of it and that the applicable donations tax is paid in the year of donation. Should you still wish to lend the money to the trust, you could use a small portion of the returns to purchase a life policy to cover the estate duty still payable on the outstanding loan.

Other options

Of course, there is also the option of investing in your personal capacity, whether locally or offshore, and having the trust as a beneficiary (remembering though that local trusts cannot hold offshore assets if you wish to financially emigrate). We have associates offshore that can assist with the setting up of freezer trusts which become active on the death of the investor.

Alternatively, you can nominate beneficiaries for the offshore investments in order to prevent the assets being repatriated to South Africa. As this is a deemed asset in your estate there will be estate duty payable on any portion that is not bequeathed to your spouse and there will also be capital gains tax payable at preferential rates within the investment.

It’s also important to remember that a recent amendment to the Estate Duty Act has seen the introduction of estate duty at a rate of 25% for dutiable estates in excess of R30 million after the primary rebate of R3 500 000. Bear in mind that any bequest to a surviving spouse is exempt and that the primary rebate also passes on to the surviving spouse if this rebate is not used in full. Thus the primary rebate aggregates to R7 million for a married couple.

Reach out to your financial adviser

The best way to invest in a trust, whether onshore or offshore, will depend on your personal circumstances. As you can see, there are many considerations to take account of when making such important decisions. Your financial adviser is the best person to reach out to for financially sound advice.

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