WHEN IS A TRUST THE APPROPRIATE SOLUTION?

Article by listed attorney:  Nicolen Schoeman

Introduction

A trust is defined as: “A relationship created at the direction of an individual, in which one or more persons hold the individual's property, but subject to certain duties to use and protect it for the benefit of others.”[1]

Put simply: a trust is established by a person (the founder) who donates their assets to the trust. The trustee(s) administer(s) the trust’s assets for the benefit of a third-party beneficiary. This means that the very core of the trust concept is that the powers and function of the founder are separated from the trustees and beneficiaries. Furthermore, trusts are administered according to the provisions of the Trust Property Control Act 57 of 1988.

Trusts are well-known as vehicles to facilitate effective estate planning and continuity planning strategies, and are often the hot topic of discussion when trying to keep up with the Joneses. That said, setting up a trust − whether inter vivos (between the living) or testamentary (created in a will) − should be carefully considered and not just implemented blindly.

Broadly speaking; trusts are classified into two categories: testamentary and inter vivos trusts. However, for income tax purposes, trusts are further classified as either vesting or discretionary trusts, and this determines when tax is payable and who pays it.

If you have identified that a trust is the best way to achieve your objective, then further identifying the correct trust for your purpose is imperative to avoid incurring unnecessary or excessive costs.

Testamentary trusts

A testamentary trust is established when a person (the founder) makes provision for establishing a trust in their will. Accordingly, the trust does not come into existence until the founder dies. These trusts are commonly applied where the deceased has maintenance or support obligations. For example, they might be obliged to look after the financial needs of minor children, disabled family members or the elderly.

A testamentary trust is particularly useful for looking after dependents who lack the capacity, by law or otherwise, to receive an inheritance. In terms of South African law, a minor child may not inherit. If provision has been made for looking after a minor child, the child’s inheritance is often paid into the Guardian’s Fund, which is a state-owned fund. When setting up a testamentary trust to look after either minor children or other dependents, the testator (trust founder) is in complete control of who manages the heir’s inheritance; the circumstances under which payments are made, the trustees’ duties and powers; and − ultimately − when the trust terminates.

Setting up a testamentary trust may not only safeguard assets inherited by dependents from the claims of creditors, but they can also meet the dependents’ needs when the founder is no longer able to do so.

Finally, setting up a testamentary trust may also be particularly useful for continuity planning. In this case, setting up an inter vivos trust is usually the most appropriate solution. But, ultimately, the choice depends on the specific needs of the person or business involved and the objective they are aiming to achieve.

The most important factor note is that during the founder’s lifetime, the assets they plan to transfer to the trust on their death remain under their direct control while they alive. Accordingly, the founder never relinquishes this control before they die.

Inter vivos trusts, on the other hand, work in a completely different way.

Inter vivos trusts

In contrast to testamentary trusts, the inter vivos trust is set up between the living. In other words: property is transferred before death to the trust by its founder and managed by the trustees for the benefit of another person or persons, the beneficiary(ies). Accordingly, the founder relinquishes direct control over the assets.

This is one of the most important considerations when deciding whether or not to establish an inter vivos trust. Specifically, you need to be absolutely certain whether or not the founder is indeed willing to relinquish direct control over assets transferred to the trust. If they are not willing to relinquish control, trusts are often set up in such a way as the founder retains direct control. This can mean the trust is never actually established in the first place, or any transactions are reversed, or the trust is terminated.

This was specifically illustrated in the case of Thorpe v Trittenwein 2007 2 SA 172 SCA, where the court stated:

“…Not infrequently in the past, trusts have sought to escape contractual obligations... In dismissing the appeal, the court noted that the result may seem ‘somewhat technical’ as Thorpe was the founder of the trust, clearly the dominant trustee and also a beneficiary. It observed that the trust in question was ‘typical of the modern business or family trust in which there is a blurring of the separation between ownership and enjoyment, a separation which is the very core of the idea of a trust’. Those who make use of a trust to conduct business cannot enjoy the advantage of a trust when it suits them and cry foul when it does not.”

Therefore, where owners are not willing to honour the true nature of the trust structure, the act of transferring assets to the trust in an attempt to (unlawfully) safeguard the assets may be reversed by order of a court of law and creditors can still lay claim to it. This applies even though one of the most important and beneficial features of a trust is that it safeguards assets from the claims of creditors.

In addition to safeguarding personal assets from these claims, safeguarding assets or meeting dependents’ maintenance needs, trusts are also particularly useful in continuity planning structures and some commercial transactions.

From a continuity planning perspective, it may be useful to hold company shares in a trust. This ensures your business continues to operate after you die with minimal disruption. This is because you were in a position to select the most appropriate people to become shareholders or even directors of your business, depending on the circumstances. Furthermore, by executing the most appropriate agreements, this approach could also prevent unnecessary disputes over who owns your business or whether it should be sold after you die.

Finally, some commercial transactions, such as Broad-Based Black Economic Empowerment transactions, often involve using trusts specifically in employee share schemes. Here, safeguarding the shareholding is particularly useful.

Conclusion

Trusts of any type are particularly useful when the reasons for implementing them are clearly thought through. However, beyond considering the specific purpose and best solution, trusts are also relatively expensive vehicles. Therefore, as a rule of thumb in estate planning, only non-income generating assets are suitable for trusts.

This is because, in some instances, the trust is taxed as a separate legal person from the beneficiaries (and trustees). In other instances, the donor, or founder (the original owner of the asset transferred to the trust) or the beneficiary may be taxed, regardless of whether or not any assets or benefits were actually paid or released to the beneficiary. These factors depend largely on how the trust deed has been structured.

Given these complexities, seeking appropriate expert legal advice before implementing a particular estate planning strategy or trust structure is imperative.

Nicolene Schoeman, Schoeman Attorneys (Cape Town)

 

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