Protecting the tax base through trust taxation reform

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In an attempt to protect the South African tax base, the taxation of trusts will be completely overhauled.  Trusts have long been viewed as vehicles for tax avoidance due to their flexibility and flow through nature.  Applying the flow through concept essentially results in income being taxed in the hands of the beneficiaries and very little, if anything, being taxed in the trust itself (making it largely tax neutral).  The proposals are not intended to affect special trusts, established to cater for the needs of minor children and disabled people. 

The biggest change we will see is in this area is the taxation of discretionary and trading trusts at the trust level, thereby, no longer treating these as flow through entities.   On this basis, taxable income will be calculated in the hands of the trust, with any distributions to beneficiaries being treated as deductions by the trust.  The beneficiaries on the other hand would for the most part, receive a tax free distribution from the trust. This is a fundamental shift from the way that trusts are currently being treated for tax and will put trusts at on an equal footing as other taxpayers, for example, companies but subject to tax at a higher rate of tax.  The purpose of the changes being to discourage alleged misuse and abuse of trusts for tax planning.

Revised treatment of captive insurers

Over recent years, policy makers have been reviewing captive insurance arrangements (essentially self insurance arrangements).  This was fuelled by the fact that these are in essence seen as  “investments” by the insured as opposed to a proper contract of insurer with genuine risk being transferred to the insurer.  Some of the proposals to deal with this situation included disallowing of premiums paid by a policyholder to a short term insurer where the arrangement is found to lack proper risk transfer.  The original proposals were found to be wanting as they focused on the insurer as opposed to the insured (policyholder).  Other anti-avoidance measures that are being considered include, the treatment of dividends received from captive insurers, which will in all likelihood result in these being taxed in the hands of the recipient. 

Furthermore, it is intended that the proposed anti-avoidance rules will also be extended to long-term insurance policyholders on re-insurance policies that also lack a significant element of risk transfer (i.e. have an investment flavour).