Special trusts for minors and those with special needs
Treasury repeatedly emphasises that measures are being put in place to clamp down on trusts for perceived tax avoidance, but we’ve seen that special trusts are excluded. Special trusts are, in our opinion, the ideal vehicle to benefit individuals unable to manage their own finances – such as disabled or mentally handicapped persons, or minors. Compared to other trusts, they enjoy a host of tax benefits, but they also have their fair share of qualifying requirements as set out in the Income Tax Act (ITA).
The tax benefits of special trusts:
- The new section 7C of the ITA that came into effect on 1 March 2017, which levies a donation tax liability on the interest foregone on interest-free or ‘low interest’ loans made to trusts, will not apply to such loans made to special trusts
- The rate of income tax applicable to special trusts was not increased to 45% after the Budget Speech in February this year, as was the case with other trusts, but has been kept the same as for natural persons on a sliding scale relevant to the income brackets
- Type A special trusts – trusts created solely for the benefit of persons with disabilities – enjoy a maximum effective rate of capital gains tax (CGT) of 18% (as is the case for natural persons), instead of the 36% applicable to other trusts
- Type A special trusts are entitled to an annual exclusion for CGT purposes in the same way that natural persons are
- A type A special trust that is discretionary must disregard a capital gain or loss not exceeding R2 million on the disposal of a primary residence, just like a natural person
- A capital gain or loss on the disposal of personal use assets by a type A trust must be disregarded, as is the case with natural persons
- A capital gain or loss on the disposal of a claim for the receipt of compensation by the trust for personal injury, illness or defamation of the trust beneficiary by a type A trust must be disregarded, as is the case with natural persons.
Types of special trusts
- Type A special trusts are set up for the benefit of one or more persons who is/are disabled as defined in section 6B(1) of the ITA and who are relatives.
- Type B special trusts are those set up in a will for the sole benefit of the relatives of a deceased person, and of which the youngest of the relatives is under the age of 18 years.
Type A special trusts
For a special trust to qualify as a type A trust, it has to comply as follows:
The disability requirement:
- A disability is defined in section 6B(1) of the ITA as ‘a moderate to severe limitation of any person’s ability to function or perform daily activities as a result of a physical, sensory, communication, intellectual or mental impairment, if the limitation:
- has lasted or has a prognosis of lasting more than a year; and
- is diagnosed by a duly registered medical practitioner in accordance with criteria prescribed by the Commissioner.’
- The requirement is that the disability has to significantly restrict the person’s ability to function or perform one or more daily basic activities after maximum correction. Maximum correction means appropriate therapy, medication and use of devices.
The sole benefit requirement:
- The trust deed may not provide for any possibility that any beneficiary who does not have the ‘disability’ as defined, may benefit.
The incapacity and financial management requirement:
- Beneficiaries must not be able to earn sufficient income for their maintenance, or manage their own financial affairs, as a result of their disability. This is very much a factual question to be answered on the specific facts in each case.
The living beneficiaries requirement:
- At least one of the beneficiaries for whose sole benefit the trust has been created should be alive on the last day of February of the relevant year of assessment of the trust.
- The trust will cease to be a type A trust from the start of the relevant year of assessment during which all the beneficiaries for whose sole benefit the trust was created, are deceased.
The relatives requirement:
- A trust that is created for the sole benefit of more than one person must be for the benefit of persons with a disability who are related to each other. A ‘relative’ as defined in section 1(1) of the ITA, means:
- The spouse of that person
- Anyone related to that person within the third degree of consanguinity
- Anyone related to the spouse of that person within the third degree of consanguinity
- The spouse of anyone related within the third degree of consanguinity to that person or that person’s spouse.
- A ‘spouse’ is defined in section 1(1) and means a person who is the partner of such person:
- In a marriage or customary union recognised under the laws of South Africa
- In a union recognised as a marriage in accordance with the tenets of any religion
- In a same-sex or heterosexual union that the Commissioner is satisfied is intended to be permanent.
Type B special trusts
A type B special trust has to comply as follows:
- A trust will remain a type B trust if one of the qualifying beneficiaries of the trust dies subsequent to the date of death of the deceased person as long as the trust continues to comply with the other requirements of paragraph (b) of the definition of ‘special trust’ in section 1(1), namely, that the remaining beneficiaries are related to the deceased person and the youngest beneficiary is under the age of 18.
- Beneficiaries may include persons aged 18 years and older as long as one of the beneficiaries is still under the age of 18 years.
The ‘under the age of 18 years’ requirement:
- The youngest of the beneficiaries of a type B trust must be under the age of 18 years on the last day of the relevant year of assessment of the trust.
Mode of formation of special trusts
- In order to register and form a special trust for income and CGT purposes, the trust must complete an IT77TR form to which the trust deed in the case of an inter vivos trust or the last will and testament of the deceased person in case of a testamentary trust must be attached.
- Additional documentation must be submitted in the case of a type A special trust:
- Medical report from a medical practitioner or medical institution confirming the nature of the disability of the beneficiary of the special trust
- A medical report from a medical practitioner or medical institution confirming that the disability incapacitates the beneficiary from earning sufficient income for that person’s maintenance or from managing that person’s own financial affairs.
- The trustees must indicate the type of trust on the return of income of the trust (ITR12TR).
- A special trust that derives income other than remuneration or an allowance or advance contemplated in section 8(1) must be registered as a provisional tax payer.
With the current close scrutiny applied to trusts, trustees of special trusts should ensure they comply with all the above requirements, as non-compliance may result in unintended negative consequences, especially from a tax point of view. If you need assistance in setting up a special trust and/or advice with regard to special trusts, contact Stanley Broun at email@example.com or at 011 778 6648.