In a previous article the use of trusts in companies as valuable BBBEE planning strategies was highlighted; specifically from a compliance perspective.
Using trusts as estate planning vehicles mainly to house shareholding has become an equally effective estate planning and business continuity planning strategy. However, some vital tax and other implications are often missed and the entire estate planning or liquidity planning as a result completely missed.
In order to fully understand the strategy envisioned it is important to investigate the nature and purpose of a trust first. 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
In Agricultural Bank of SA v Parker 2005 2 SA 77 SCA, the court held that:
"The core idea of the trust is the separation of ownership (or control) from the enjoyment. Though a trustee can also be a beneficiary, the central notion is that the person entrusted with control exercises it on behalf of and in the interests of another. This is why the sole trustee cannot also be the sole beneficiary. Such a situation would embody an identity of interests that is inimical to the trust idea, and no trust would come into existence."
A trust is established by the founder who donates their assets to the trust. Trustees administer the trust assets for the benefit of a third party beneficiary.
The very core of the trust concept is that the powers and function of the founder are separated from the trustees and the beneficiaries.
Trusts are administered according to the provisions of the Trust Property Control Act 57 of 1988.
So, trusts are effectively a separate entity from the trustees. The beneficiaries may be trustees as well, but it is important that the trustees are not the only beneficiaries (absence of an independent trustee).
Importantly, this a valuable structure as trustees ensure continuity where one of them or the beneficiary passes on, as the trust is the shareholder and not the individual. So, choosing trustees with the necessary business acumen is of the utmost importance from a business continuity perspective.
Moreover, the tax implications for the trust are limited to the dividends so declared. However, the taxation of trusts depends on their inherent nature and for this reason it is of the utmost importance that these are properly considered with professional assistance.
So, how do buy and sell agreements and key man insurance impact on the situation when the shareholders are trusts?
Buy and sell agreements and key-man insurance
Key person insurance, also commonly called key-man insurance, is an important form of business insurance. Generally, it can be described as an insurance policy taken out by a business to compensate that business for financial losses that would arise from the death or extended incapacity of an important member of the business.
A buy and sell agreement which usually goes hand in hand with key-man insurance on the other hand is also known as a buyout agreement in some jurisdictions. The provisions may even be contained in a traditional shareholders agreement. Essentially, it is a legally binding agreement between co-owners of a business that governs the situation if a co-owner dies or is otherwise forced to leave the business. In this context and for purposes of this article, the situation tends to arise at death.
On death specifically there are a number of tax implications for business owners generally as the life insurance policy or key-man policy may form part of the deceased's estate as "deemed property" in terms of section 3 of the Estate Duty Act 45 of 1955.
However, if these policies meet certain requirements they are exempt:2
- If the policy was acquired by a person who was at the deceased's death a member or shareholder or partner in the business with the deceased,
- The policy was taken out for the purpose of acquiring the deceased's share in the business,
- No premium was paid or borne by the deceased.
A further exemption generally in terms of insurance policies, where:3
- The policy was not taken out by the deceased,
- No premium was paid or borne by the deceased,
- No amount is due or recoverable under the policy or will be paid into the deceased estate,
- No amount will be paid or otherwise utilised by the relatives or dependents (wholly or in part) or any family business in relation to the deceased.
So, what about the tax implications when the shareholders are trusts?
The situation is quite simple according to the SARS directive of 27/05/2007, where both shareholders are trusts, the exemption will not apply, simply because the trustees on whose life the policy will be taken out are not shareholders themselves, the trusts are.
If, however, a policy is taken out on the life of a partner or shareholder who holds the shares in his personal capacity, the exemption should apply.
It is therefore of fundamental importance that where trusts are used for business continuity and estate planning, clients are advised by attorneys specialising in the field in order to facilitate the most suitable solution.
1. http://legal-dictionary.thefreedictionary.com/trust: accessed 20 November 2009. Section 1 of the Trust Property Control Act 57/1988 defines a trust as: the arrangement through which the ownership in property of one person is by virtue of a trust instrument made over or bequeathed-is by virtue of a trust instrument made over or bequeathed- (a) to another person, the trustee, in whole or in part, to be administered or disposed of according to the provisions of the trust instrument for the benefit of the person or class of persons designated in the trust instrument or for the achievement of the object stated in the trust instrument; or
(b) to the beneficiaries designated in the trust instrument, which property is placed under the control of another person, the trustee, to be administered or disposed of according to the provisions of the trust instrument for the benefit of the person or class of persons designated in the trust instrument or for the achievement of the object stated in the trust instrument...."
2. Section 3(3)(a) o0f the Estate Duty Act 45 of 1955.
3. Section 3(3)(a) o0f the Estate Duty Act 45 of 1955.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.