These days, trusts seem to be at the centre of almost every estate plan. They are touted as a way to save on income tax, estate duty and to safeguard assets from attachment by creditors. But, as with so many tax avoidance schemes, its success is often not the result of the plan, but that of - let us say - not the whole truth, though nothing but the truth… What is worse, in my experience it is often the advisor – financial planner, attorney or accountant – who effectively turns the client into a liar.
Imagine convincing a client of the following estate plan: “Well Mr. X, I have the perfect solution for your estate duty problem – you should give away all your assets to a charity and you won't have to pay any estate duty”. Could you convince your client to accept this proposal? Probably not, because there does not seem to be any benefit in it for him. And yet this is rather close to what using a trust to save on estate duty entails.
If we turn to section 1 of the Trust Property Control Act (Act 57 of 1988), three aspects of the definition of a ‘trust' are noticeable. The first is that it requires you to hand over your assets and to fully divest yourself of the ownership thereof. The second is that the assets are handed to trustees to be administered for the benefit of a beneficiary or group of beneficiaries – i.e. somebody other than the donor. The third is that this administration is to be done in accordance with the terms of the trust agreement.
To a large extent the question is one of who has control of the trust assets and who is entitled to its benefits. In this regard reference should be made to the case of Land and Agricultural Bank of SA v Parker [(2005 (2) SA 77 (SCA)], in which the court states: “The essential notion of trust law, from which the further development of the trust form must proceed, is that enjoyment and control should be functionally separate.”
However, because it is difficult for clients to conceive of a ‘solution' that requires them to give away their assets, advisors in ‘selling' their solution may feel compelled to soften the blow somewhat. It is explained to the client that he will still be entitled to benefit from the assets as a beneficiary of the trust. It is also explained that the trustees will jointly administer the assets for the benefit of the beneficiaries.
However, the client usually still feels uncomfortable – the solution after all requires him to give away his assets. Typically also, a client in an estate planning exercise has very definite ideas regarding how he wants the assets to be distributed. And as he is the one giving away his assets, he feels entitled to prescribe how the assets are to be used or allocated to the beneficiaries. It is when addressing this discomfort that clients and their advisors start stepping across the line, albeit not intentionally.
Let's have a look at how this discomfort is usually, and incorrectly, addressed. As a result of the client's fear of relinquishing control over trust assets, advisors, when drafting a trust deed, include clauses to try and appease the client. The following are examples of that type of clause:
The client could also appoint trustees who do not bring any individual thought to their position and merely act as extensions of the client himself, thus in effect being nothing more than a puppet of the client. It makes no difference whether or not the client himself is a trustee of the trust – factually he controls the decisions that the trustees are making in these circumstances.
Alternatively, the client could try to control the trustees by way of a “letter of wishes” in which he expresses his desire, upon his death, for the trustees to act in a specific way with the trust assets.
But, can it be said that the client, in these circumstances, relinquished control over the assets? Did he really hand over the assets to the trustees? Is he actually using the trust to create an impression of parting with his assets, while in reality, doing all in his power to retain the rights and powers associated with ownership? Are they not, the client and his advisor, merely creating a sham and putting up a show for the benefit of onlookers? It would seem that clients, on the strength of the advice received, want the benefits of reduced tax liability (by way of the conduit principle), reduced estate duty liability or protection of assets from creditors, while at the same time attempting to ‘keep' the assets for themselves, or at least under their control.
Advisors should take note of the application of the doctrine of substance over form in our law. In simple terms the law is not interested in the guise in which an action is cloaked, but interested only in the substance thereof – i.e. what it really is. This means: It is not important what phraseology is used in a trust deed, or letters of wishes, in an attempt to hide the reality of the situation. The law, and as such our courts, is interested in the reality of the situation. The result of the application of this doctrine is that the court can ignore the existence of a trust and make an order as if the trust did not actually exist.
Two cases come to mind. In the case of Badenhorst v Badenhorst [2006 (2) SA 255 (SCA)], the court effectively ignored the existence of the trust, and looked past the trust and treated the trust assets as the assets of the founder for the purposes of sec 7(3) of the Divorce Act (Act 70 of 1979), because of that person's de facto control of the trust assets. In similar circumstances in 2001, the court had come to the same conclusion in the case of Jordaan v Jordaan [2001 (3) SA 288 (C)], in which the husband had used the trust as his alter ego. What is important to note though, is not the application of the principle with regards to divorce law, but the court's willingness to ignore the existence of the trust if it is used incorrectly.
As a result of the application of the doctrine of substance over form one could easily find oneself in the position where trust assets are attached for the personal debts of the donor or the ‘controlling' trustee, which would negate one of the reasons for the trust in the first place, namely the protection of assets from creditors. Consider also the effects of the application of the anti-avoidance measures contained in the various tax statutes (e.g. section 103 of the Income Tax Act, Act 58 of 1962). The application of the doctrine of substance over form could negatively influence the outcome of an action under one of these sections. Further, SARS is well aware of the abuse of trusts especially in an attempt to avoid estate duty. The Estate Duty Act (Act 45 of 1955) contains provisions that would allow SARS in appropriate circumstances to tax trust assets in the estate of a controlling trustee or donor. Unfortunately advisors are often unaware or ignore the risk and the impact that section 3(3)(d) of the Estate Duty Act could have on their clients.
In terms of this section SARS can levy estate duty on assets that would not ordinarily be dutiable in the deceased's estate. In this case the assets are deemed to be assets of the deceased on the basis that he was “...immediately prior to his death competent to dispose (thereof) for his own benefit or for the benefit of his estate.” When interpreting section 3(3)(d), consider also the wide phraseology and the scope of section 3(5) which reads as follows:
“5) For purposes of paragraph (d) of sub-section (3)--
a) the term "property" shall be deemed to include the profits of any property;
b) a person shall be deemed to have been competent to dispose of any property--
i) if he had such power as would have enabled him, if he were sui juris, to appropriate or dispose of such property as he saw fit whether exercisable by will, power of appointment or in any other manner;
ii) if under any deed of donation, settlement, trust or other disposition made by him he retained the power to revoke or vary the provisions thereof relating to such property;
c) the power to appropriate, dispose, revoke or vary contemplated in paragraph (b) shall be deemed to exist if the deceased could have obtained such power directly or indirectly by the exercise, either with or without notice, of power exercisable by him or with his consent;
d) the expression "property of which the deceased was immediately prior to his death competent to dispose" shall not include the share of a spouse of a deceased in any property held in community of property between the deceased and such spouse immediately prior to his death.”
Take note too of the fact that assets can be deemed to be that of the donor or the controlling trustee even when such person is not actually entitled to share in the trust capital, merely because they have, or could have obtained, the power/s referred to above.
The application of the doctrine of substance over form and/or section 3(3)(d) can, to a large extent, be avoided by ensuring the following:
In conclusion, be sure that your trust is structured so that it will actually protect your assets against legal action. asa
Author: Franscois van Gijsen, C B Proc, LLM (Tax), Dip (Legal Practice), Certified Financial Planner, is Director: Legal Services, and Nico van Gijsen, BA (Hons), MA, is Managing Director at Finlac Risk and Legal Management.