Trusts: Clogged and trapped capital losses
By Deanna Comninos, Senior Manager, Deloitte
Deloitte Budget 2012 Expectations
Johannesburg, 23 January 2012 - Historically, the perception around trusts has been that they are utilised as planning vehicles to avoid or evade tax and some strong anti-avoidance legislation has been put in place to curb the perceived misuse of trusts.
One of the points of contention surrounding Trusts relate to the ring-fencing of capital losses in Trusts. Currently, the Income Tax Act only allows the gain made on the disposal of a specific / identifiable asset to be attributed to a donor (i.e. the person who funded the trust by making a donation, settlement or other disposition to the Trust) or vested in a beneficiary. In other words, where a Trust makes both gains and losses in a tax year by disposing of various assets, the “net capital gain” of the Trust cannot be attributed to the donor or vested in a beneficiary.
The implication of the ring-fencing of tax losses is that the beneficiaries of Trusts will never be in a position to utilise the capital losses in Trusts even in situations where assets are vested in or distributed to such beneficiaries and the Trust concerned makes a capital loss in the process.
For resident Trusts, capital gains may be attributed to the donor (the person who has made a donation, settlement or other disposition to the Trust), while capital losses will only be utilised to the extent that the Trust becomes self-funded over time. Capital losses in offshore trusts will remain unutilised in perpetuity since there is no mechanism to set off the losses against future gains. This creates a rather unfair result for South Africans with offshore trusts who have weighted their investment portfolios toward foreign currency assets over the past few years. With the strengthening of the Rand this has resulted in substantial capital losses and, since the portfolios are held in offshore Trusts, taxpayers will not be able to utilise these capital losses and may be taxable on gains made merely because the value of the Rand has weakened.
Another issue is that a person cannot include a capital loss in the determination of his/her aggregate capital gain / aggregate capital loss if the capital loss concerned resulted from the disposal of asset to a connected person. The capital loss can only be deducted from capital gains made on the disposal of assets to the same connected person. Consequently, even if a transaction between connected persons is in all respe
We consider that this creates an unfair situation in that a person may wish to effect, for example, a disposal to a Trust for asset protection purposes without any future transactions between them. Thus even if the transaction is in all respects on an arm’s length basis, there is no intent to avoid tax, and taking into account that the attribution rules may in any case apply, the loss will remain unutilized in perpetuity.
While one can appreciate that certainly there has been abuse of Trust structures in the past, some of the above implications are creating inequitable consequences for taxpayers, who are making legitimate use of Trusts through in arm’s length transactions. To that end, a less severe and more simplified approach could be that the net capital gain (after setting off capital losses) of a Trust be attributed to a donor or vested in a beneficiary and that any capital losses be carried forward and not lost entirely.
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