L e g a l a n d T e c h n i c a l U p d a t e

LEVERAGENote from the editorSharon Hamman (née Teubes), Senior Legal Adviser: Advice and Wealth Management

November/December 2016

Donald Trump is the new elected President of the United States of America – I am yet again totally and utterly speechless.

On the local front, I asked for a happy ending to this year and it seems my genie has fulfilled my wish with a good news story: the NPA dropping the charges against Finance Minister Pravin Gordhan. The impact was immediately felt with the Rand strengthening; hopefully the damage to our credibility can be limited. It is hard to believe that it is almost a year since the start of the Finance Minister spectacle – and what a spectacle it has been! I did not expect for my wish to be granted twice, but with the release of the ‘State Capture’ report, it was! Finally, it seems that the interests of our beautiful country are being put ahead of that of any party or politician. We are definitely living in interesting times…

This last month saw the publication of the second draft of the Taxation Laws Amendment Bill tabled in Parliament and likely to be accepted in its current form. In this edition, I will summarise the proposed Section 7C pertaining to trusts and recap on the practicalities. We will only do an in-depth discussion on the matter once it becomes law.

Please remember that trusts are used for many viable reasons, of which tax planning is only one. If the new legislation renders a trust to a specific client obsolete,then perhaps a trust was not the right vehicle

to implement from the start. Also remember that unbundling a trust will in itself require specialised advice and inevitably result in costs and possible taxes being incurred, so tread carefully. Please contact our trust and fiduciary specialists in Momentum Trust for specialised support.

In this edition I pay special attention to disallowed contributions when making retirement fund contributions and the technicalities around this. I highlight the importance of asking the simple question to a client (who is retiring) or to the beneficiaries (where a member has died): ‘Do you have any disallowed contributions that have rolled over?’

Tanya will share an interesting case that shows the power of the courts in respect of trustees of trusts – definitely an interesting read.

As this is the last edition for 2016, we would like to wish you all a peaceful, happy and safe festive season. May you return with new vigour and energy for 2017. If 2016 was anything to go by, 2017 might be many things, but dull will not be one of them. Our first edition for 2017 will be ready mid-February!

Happy reading!

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Do not forget about disallowed contributions…By Sharon Hamman, Senior Legal Adviser: Financial Planning

The Income Tax ActSection 11(k) provides the framework and limits in terms of which retirement fund contributions can be deducted from income when determining taxable income. Shortly stated, the deduction is limited to the lesser of:

• R350 000 or

• 27.5% of the greater of remuneration or taxable income

Section 11(k)(ii) determines that an amount contributed to a retirement fund in any previous tax year and that was disallowed due to it exceeding the abovementioned limitation in that given year, is deemed to be an amount contributed in the current tax year, except to the extent that the amount has been:

• Allowed as a deduction against income in any year or assessment under section 11(k)

• Accounted for under paragraph 5(1) or 6(1) of the Second Schedule or

• Exempted under section 10C

The Estate Duty ActSection 3(2) determines that a person’s estate shall consist of all property of that person as at date of death. Property includes the amount of contributions made by the deceased to a pension, provident or retirement annuity fund that was not allowed as a deduction in

terms of section 11(k) or paragraph 2 of the Second Schedule to the Act or as was not exempt under section 10C.

Therefore, the disallowed contributions as at date of death will be included in the estate for estate duty purposes.

Practicalities – during the contributing taxpayer’s lifetimeThe practicalities are best illustrated by way of an example. Tabiso’s taxable income is R750 000 per annum. He is self-employed and his remuneration is less than his taxable income. Therefore, the maximum allowable deduction in that year is R206 250 (at 27.5% of R750 000).

Tabiso contributed R360 000 for that year and therefore the disallowed contribution for that tax year is R153 750.

This amount will roll over to the following tax year:

• To be deducted along with any new contributions made during that year or

• To be applied against a retirement fund lump sum when determining the taxable lump sum in terms of the Second Schedule or

• To be applied against any compulsory annuity income as an exemption in terms of section 10C

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Tabiso continued with the contributions as follows, until age 60:

Retirement fund contribution

Remuneration Maximum deduction Disallowed contribution

Total disallowed contribution

R380 000 R785 000 R215 875 R164 125 R317 875

R400 000 R820 000 R225 500 R174 500 R492 375

R410 000 R880 000 R242 000 R168 000 R660 375

R425 000 R960 000 R264 000 R161 000 R821 375

R1 500 000 R1 000 000 R275 000 R1 225 000 R2 046 375

At age 60, Tabiso retires from his retirement annuity fund and transfers the full fund value of R5 000 000 to a living annuity. He draws an income of R700 000 per annum. During that year of assessment, he also retires from a small provident preservation fund and he elected to take the full lump sum, which amounted to R550 000.

When calculating the taxable lump sum, the disallowed contributions are a deduction in terms of the Second Schedule. As the total disallowed contributions are equal to R2 046 375, the lump sum from the provident preservation fund will be tax-free. This will result in the disallowed contributions being reduced by R550 000.

Tabiso’s income from the living annuity will also qualify for an exemption in terms of Section 10C. Therefore, the R700 000 will be exempt from income tax. Any PAYE deducted during the year by the administrator will be refunded to Tabiso. The effect is that the disallowed contributions are reduced by this R700 000.

If one assumes that Tabiso no longer makes any new contributions to his retirement funds and that his gross income for the year consists out of the living annuity income and income from his business of R250 000, the maximum tax deduction that Tabiso can claim in this tax year in respect of the disallowed contributions that rolled over will be calculated as follows:

Living annuity income R700 000

Business income R250 000

Gross income R950 000

Less exemption ito section 10C R700 000

Income R250 000

Less retirement fund contribution R261 250

(27.5% of R950 000 (remuneration))

Taxable income R0

Due to the income being less than the deductible amount, the disallowed contributions that are rolled over

to the following year will only be reduced by theR250 000 that was actually enjoyed as a deduction and not the full claimable amount. As the contributions were not effectively made, but were due to a roll-over, the R11 250 that is not deductible will not increase the disallowed contributions that roll over.

Therefore the disallowed contributions that roll over to the following tax year are equal to:

Disallowed contributions at beginning of tax year

R2 046 375

Less lump sum in terms of Second Schedule

R550 000

Section 10C exemption R700 000

Deduction of disallowed contributions (limited to)

R250 000

Disallowed contribution rolling over to following year

R546 375

Practicalities – upon the death of the contributing taxpayerIt is important to remember that the benefit of disallowed contributions can only be enjoyed by the person who made the contributions and not by the beneficiaries of that person –it does not roll over to the beneficiaries.

The implication is that if it is not used, it will be lost.

Let’s continue with the example of Tabiso. He dies at the end of the tax year and the living annuity’s value is R5 000 000. He nominated his spouse as the beneficiary. She has the following options:

• Continue with a living annuity or

• Take a lump sum or

• A combination of the two

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If she continues with the living annuity, the R536 375 disallowed contributions that Tabiso had remaining, will be lost. In addition, this amount will also be included in his estate for estate duty purposes.

If she elects to take a lump sum, that lump sum will be taxed in Tabiso’s hands as if he elected to take the lump sum the day immediately before his death. Therefore, if his spouse elects to take a lump sum of R536 375, it will pay out to her tax-free as his disallowed contribution will be applied against this lump sum to determine the taxable portion. The effect is that the disallowed contributions remaining on date of death will be zero, which will result in no asset to be included in his estate for estate duty purposes.

If one goes one step further, Tabiso’s spouse can now invest this tax-free lump sum in a voluntary purchased annuity to provide her with tax efficient income. Alternatively, she can invest it in her own retirement annuity. If she retires from the retirement annuity shortly thereafter and transfers the full fund value to a living annuity, the disallowed contributions that she made to this retirement annuity will provide relief as an exemption in terms of Section 10C against the living annuity income and it will also qualify as a tax deduction in terms of Section 11(k) within the normal limits. Once the disallowed contributions are exhausted, the income will be fully taxable again.

Administrative reminderCompulsory annuity income:

• The administrator is obliged by the Fourth Schedule to withhold PAYE when making the income payment to the annuitant.

• The annuitant will claim any Section 10C exemption at the end of the tax year, which will most likely result in a refund of the PAYE deducted.

Retirement/withdrawal or death claim:

• Where a lump sum is elected by the member on retirement or by the member’s beneficiary, it is important to inform the administrator of the disallowed contributions. If they do not know about it, they cannot ensure that it is taken into account when the tax directive is requested and issued.

• Proof of the disallowed contributions that exist will be required. The last ITA34 of the client will be sufficient proof.

• When disallowed contributions are available, the tax directive application process is different and more time-consuming and the client’s expectations should be managed.

• In general, a tax directive is requested electronically and the process is quick and simple. However, when disallowed contributions must be considered, a manual request must be submitted to Sars, which can take up to 21 business days to finalise.

ConclusionThe information contained in this article is based on the author’s interpretation of current legislation. This article is not intended to be tax or financial advice, but merely to highlight the technicalities around disallowed contributions. It is also intended to prevent any delays when assisting a client and ensure that the best and most appropriate advice can be provided.

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An introduction to Section 7C of the Income Tax ActBy Sharon Hamman, Senior Legal Adviser: Financial Planning

Note – this is an initial interpretation of the newly proposed section and is subject to change.

This section shall apply in instances where a loan (advance/credit) is made by a natural person to a trust, where that person is a connected person in relation to that trust. It also includes a loan made to a trust by a company – where the loan is made at the instance of a person that is a connected person in relation to that trust and that company.

(A connected person in relation to a trust will be a beneficiary of that trust. In the case of a company, a connected person is a person that holds 20% or more of the shares of that company (either in his/her own capacity or jointly with a relative or a trust of which the person is a beneficiary.)

Firstly, the section determines that no deduction, loss or allowance (including capital allowance) can be claimed by the trust in respect of the disposal of a loan (that was provided by a connected person) by way of a reduction, a waiver or the failure to claim payment of the loan. This provision will apply in respect of all loans that exist between connected persons and their trusts as described above, irrespective of whether the loan is interest-bearing or not.

Secondly, if the trust incurs no interest on a loan from a connected person or incurs interest at a rate below the official interest rate (currently 8% per annum), an amount equal to the difference between the actual interest paid by the trust and this official rate of interest shall be treated as a donation made to the trust by that person. If the loan is made to the trust by a company at the instance of more than one connected person in relation to that company and trust, the donation will be treated as being done in the same ratio as their shareholding in that company during that year of assessment.

Example 1:Andrew is a trustee and beneficiary of A Family Trust. He lent the trust R1 000 000 to fund an investment held in the name of the trust. He charges no interest on the loan.

As Andrew is a connected person in relation to the trust and as there is no interest levied on the loan, Andrew is deemed to donate R80 000 (R1 000 000 x 8%) per annum to the trust. Andrew is entitled to donate up to R100 000 per annum to any other person free from donations tax, and therefore Andrew will not pay donations tax on this amount.

Example 2:Peter and Sandy are shareholders of PS (Pty) Ltd. Peter owns 80% of the shares and Sandy 20%. Both Peter and Sandy are also beneficiaries of the PS Family Trust. As directors of this company, they resolve that the company will lend R5 000 000 to the trust to purchase an investment property. The company charges interest at a rate of 5% per annum on this loan.

Therefore, the difference between the official interest rate (R5 000 000 x 8% = R400 000) and the actual rate charged (R5 000 000 x 5% = R250 000), which amounts to R150 000 per annum, is deemed a donation by Peter and Sandy to the trust. 80% of this amount will be attributed to Peter, which is R120 000, and 20% will be attributed to Sandy, which is R30 000. If one applies the annual donation exemption, it results in Sandy paying no donations tax and Peter being liable for donations tax on R20 000 (at 20%), which is R4 000.

The deemed donation provision will not apply in respect of the following trusts:

• The trust is a public benefit organisation as approved by the Commissioner in terms of Section 30(3).

• The trust is a small business funding entity approved by the Commissioner in terms of Section 30C.

• That loan, advance or credit was provided to that trust by a person by reason of or in return for a vested interest held by that person in the receipts and accruals and assets of that trust and:

− The beneficiaries of that trust hold, in aggregate, a vested interest in all the receipts and accruals and assets of that trust.

− No beneficiary of that trust can, in terms of the trust deed governing that trust, hold or acquire an interest in that trust other than a vested interest in the receipts and accruals and assets of that trust.

− The vested interest of each beneficiary of that trust is determined solely with reference and in proportion to the assets, services or funding contributed by that beneficiary tothat trust.

− None of the vested interests held by the beneficiaries of that trust is subject to a discretionary power conferred on any person in terms of which that interest can be varied or revoked.

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• The trust is a special trust as defined (set up for minors or disabled persons).

• The loan was wholly or partly used to fund the acquisition of a property used as a primary residence by that person or that person’s spouse and the loan relates to part of that loan that funded the acquisition of the property.

• The loan is an affected transaction as defined in Section 31(1) of the Income Tax Act (essentially a loan between a resident and a non-resident who are ‘connected’).

• The loan was provided to the trust in terms of an arrangement that is a sharia compliant finance arrangement as contemplated in Section 24JA, had the trust been a bank.

• The loan is subject to the provisions of Section 64E(4), i.e. the interest not charged is in substance a dividend, even if not paid by means of a formal dividend declaration in terms of that section.

The proposed effective date for this section is 1 March 2017 and it will apply in respect of any amount owed by the trust before, on or after this date.

A Court’s power to remove a trustee from office By Tanya Cohen, Fiduciary Specialist, Momentum Trust

office at common law and that this power is also derived from Section 20(1) of the TPA, which provides as set out below.

20. Removal of trustee −

(1) A trustee may, on the application of the Master or any person having an interest in the trust property, at any time be removed from his office by the court if the court is satisfied that such removal will be in the interests of the trust and its beneficiaries.

In this case, the SCA gave us the following important guidelines:

• A trustee will be removed from office when “continuance in office will prevent the trust being properly administered or will be detrimental to the welfare of the beneficiaries…” or put differently, if the conduct of the trustee “imperils the trust property or its proper administration” and his removal will be in the best interests of the beneficiaries.

• The power of a court to remove a trustee must be exercised with circumspection.

• A court may not remove a trustee because there is friction between the trustees or between trustees and beneficiaries.

• Neither are mala fides and misconduct required for (enough to warrant) the removal of a trustee.

The Court held that neither party had been able to prove misconduct, lack of capacity, breach of fiduciary duties, or any other grounds to justify the removal of the other as a trustee. All the facts supporting such allegations had been refuted by the other party. In addition, the court was not convinced that the removal of either will be in the interests of the beneficiaries.

The recent Supreme Court of Appeal case of Gowar v Gowar [2016] ZASCA (9 June 2016) dealt with the court’s power to remove a trustee from office in terms of the common law and/or Section 20(1) of the Trust Property Control Act 57 of 1988 (TPA). The outcome of the case shows that it is surprisingly difficult to convince a court to exercise the power it holds to remove a trustee of a trust. One has to prove that the conduct of the trustee “imperils the trust property or its proper administration” and his “removal will be in the best interests of the beneficiaries.”

Facts of the caseVery briefly, this case involved a dispute between Francois and Reginald Gowar. They were both trustees of various trusts (one testamentary trust and three inter vivos trusts, which owned farm land and conducted farming businesses) set up by their late father. Francois was in charge the farming operation and Reginald of the bookkeeping and finances. The accusations against one another included (a) putting personal interests above those of the beneficiaries, (b) appropriating trust assets for personal use, (d) refusing to account for his management of farm operations, (e) breach of fiduciary duties and (f) one brother surreptitiously removed the other as a beneficiary of one of the trusts, adding his own wife and children.

The dispute culminated in an application and counter-application to remove each other as trustee, that alternative trustees be appointed and empowered to distribute the trusts’ assets and thereafter terminate the trusts.

Court’s power to remove a trusteeThe Supreme Court of Appeal (SCA) confirmed that the court has inherent power to remove a trustee from

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Momentum Leverage is prepared by the Momentum Legal Advisers: Financial Planning and Fiduciary Specialists from Momentum Fiduciary Services. For financial advisers, please contact your legal adviser or fiduciary specialist should you have any questions. For clients, please contact your financial adviser should you have any questions.

Disclaimer: The views and/or opinions expressed in this article have been prepared as a primary source of information and are not a recommendation for the conclusion of a transaction. This article has been prepared for general information and not having regard to any particular person’s financial planning, tax planning, investment needs and objectives. No representation is given, warranty made or responsibility taken as to the accuracy, timeliness or completeness of any information contained in this article and MMI Group Limited will not be liable in contract or in delict or otherwise for any loss or damage arising as result of the reader relying on any such information (except in so far as any statutory liability cannot be excluded).

Please note:Any unauthorized copying or reprinting or publishing in any other publications, webpages or emails are strictly prohibited. Should you wish to use this article for any such purpose, please email Sharon.teubes@momentum.co.za to obtain permission.