Thousands of trusts in South Africa remain at risk of being set aside as 'sham' trusts by the courts, according to Keith Turberville and Mignonne Henning of Investec Trust.

"Assets worth billions of Rand could lose their protective status against tax authorities, third party creditors, disappointed beneficiaries and even irked ex-spouses," warns Henning, adding that "property held in an improperly administered trust may be treated as if it is still owned by the founder of the trust."

Because of recent rulings by the courts, tax authorities are beginning to pay even greater attention to whether trusts have been properly established and administered. Property and other assets tied up in what are deemed to be 'sham trusts' may be liable for 20% Estate Duty, levied by the South African Revenue Service (SARS) upon the death of the settler, as well as capital gains tax.

"Trust settlors, trustees and beneficiaries who are concerned about the structure and administration of their trust should have it thoroughly checked over by a professional or a professional trust company," she says.

Improper administration can also affect the validity of a trust transaction.

Turberville and Henning caution that the risk of a trust being regarded as a sham or a contract concluded by trustees being set aside increases when any of the following characteristics are evident:

• The absence of a 'paper trail' suggesting that the trust has not been properly administered;
• The founder and/or the trustees are also beneficiaries i.e. husband and wife trust;
• The founder doesn't understand the nature of the trust and treats it like a company or personal bank account;
• Trustees blindly obey any and all instructions given by a founder, this usually occurs when the trustee is a family friend or relative;
• The use of a 'letter of wishes' overrides the provisions of the trust instrument, indicating that the settlor never intended to divest himself of and hand over control of the trust assets and is in effect still controlling the asset;
• Decisions are made unilaterally without a majority decision or without the proper procedure being followed (as per the trust deed);
• The founder acts unilaterally without the written authority of the co-trustees.

"The South African courts have shown their commitment to penalising founders of sham trusts and have voided sham transactions, a bit like piercing the corporate veil" says Henning. "Ignorance is not an excuse in South African law. The consequences of a sham trust or an improperly administered trust can be far reaching, not only in the form of unexpected tax liabilities but in some cases, criminal prosecution. The best way forward is to seek professional advice.

Trustees and their advisors should be aware that the Courts seem eager to strike down a trust as a sham where there is no clear separation between beneficial ownership and the power to control the distribution of trust income and capital.

Similarly, a court finding that a trust is a sham could have a catastrophic income tax and estate duty consequences for the founder or trustees and may even give rise to claims for damages against the professional advisor in some instances.

Recent case involving assets in divorce settlement were the founder treated his trust as his alter ego had disastrous consequences in that the assets held in the trust were taken into account in determining the redistribution amount.

Among the many lessons to be learned from recent judgments is to have an objective and independent trustee or professional advisor to the trust who can assure all third parties including banks that the trust is properly administered and the trust deed adhered to, this would provide the necessary protection for all the parties concerned especially innocent third parties contracting with a trust.

Persons dealing with or requiring surety from a trust for example should be cautious particularly where the trustees and the beneficiaries are related to each other, or are the trustees themselves. One needs to take heed of the principle of "separation of enjoyment and control" says Henning which is the core principle on which trusts are founded.

Beachhead Media & Investor Relations / Investec Trust
Source: www.fanews.co.za 
22 Dec 2006