Special Trusts – Tax law and Medical Science revisited
In March 2010, the author wrote an article entitled “Tax Law and Medical Science – The Twain Have Met!”.
(To view the article click here http://www.taxtalkblog.com/?p=1114)
The said article related to the new rules introduced by Parliament, which became effective from 1 March 2009, for the tax deduction of medical expenses and in particular the deletion of the “old” definition of “handicapped person” and replacement of a new definition of “disability”.
In order for the definition to apply and thus entitle the taxpayer to deduct all “qualifying medical expenses”, one requirement is that a duly registered medical practitioner is required to complete a form prescribed by the Commissioner. There is considerable confusion and doubt among taxpayers and the medical fraternity as to who can and how the form should be completed. A discussion on these complex issues and others relating thereto is beyond the scope of this article. Suffice it to say that specialist tax law advice is recommended.
The reason for the title of that article was that since duly registered medical practitioners are required to complete a prescribed SARS form, tax and medical science are inextricably linked. Ironically, the issuance of the prescribed form has substantially raised awareness as to the ability for taxpayers to deduct all their “qualifying medical expenses” and seek specialist tax law advice in order to do so. The “new” definition of “disability” is not considerably different to the “handicapped person” definition. As a result of taxpayers now seeking specialist tax law advice in this area, the majority of those taxpayers are now, in the writers experience, obtaining substantial tax refunds as a result of successful objections made for prior years (dating as far back as 2005). A small “sugar coated pill”.
Another key area of our tax law where tax and medical issues are interlinked is “special trusts”. When considering the tax consequences of “special trusts” It is of critical importance to understand that there are two “types” of special trusts. For ease of reference, the two types of special trusts in this article are referred to as paragraph (a) special trusts and paragraph (b) special trusts.
Section 1 of the Income Tax Act No. 58 of 1962, as amended (the “Act”) contains the two paragraphs in the definition of a special trust. Broadly, paragraph (a) special trusts of the Act define trusts as they relate to certain medical conditions and other matters (for further information on this visit www.bendelsconsulting.co.za – “Press Box” in which there is an article entitled “How “special” are your trusts?”).
Paragraph (b) special trusts of the Act are broadly trusts created in terms of a will (or testamentary trusts) for the benefit of relatives (the beneficiaries) of the deceased. Such trusts cease to be “special trusts” when the youngest of the beneficiaries turns 21.
Special trusts enjoy certain tax benefits when compared to “normal” trusts”. Normal trusts are taxed at a flat rate of tax of 40% and 50% of capital gains are included. Special trusts are taxed as natural persons (although they do not obtain the tax rebate or interest exemption).
For example, if a special trust (both paragraph (a) and (b) special trusts) has taxable income of R552 000 for the 2011 tax year (none of that taxable income relates to capital gains) the trust will enjoy a tax benefit of R60 070. Tax at 40% on R552 000 taxable income is R220 800 and tax on the special trust is R160 730. Thus R60 070 is the maximum tax benefit such special trust will enjoy as any additional income in the special trust will also be taxed at 40%, being the same rate as a normal trust.
But, as mentioned above, it is of critical importance (and unfortunately taxpayers have been ill advised on this) to understand that there are the two types of trusts – the paragraph (a) special trust and paragraph (b) special trust. The fundamental reason for this is that these trusts do not enjoy all the same tax benefits. Most importantly, a paragraph (b) special trust does not obtain any favourable capital gains tax treatment when compared to a normal trust – they are taxed in the same way in the Eighth Schedule of the Act. In other words, capital gains in a paragraph (b) special trust are taxed at 20%.
Since growth assets trusts are normally placed in trust, the absence of any capital gains tax benefits for a paragraph (b) special trust means that the maximum tax saving of such a trust would appear to be limited to the R60 070, as enumerated above. When purely considered in tax terms, it is questionable whether it is worthwhile for taxpayers (and their beneficiaries) to incur the costs and administrative burden associated with such trusts.
In stark contrast, however, a paragraph (a) special trust is taxed on capital gains at 10% and obtains several exemptions contained in the Eighth Schedule. Paragraph (b) trusts obtain no such exemptions. The 10% tax saving on capital gains and other tax savings (e.g. residential accommodation exemption) for paragraph (a) special trusts makes tax planning in this area of tax law compelling. But, because detailed knowledge of medical issues are required and complex tax law matters are involved, tax planning in this area is not for the faint at heart. Intensive specialist tax care is recommended.
It is incumbent on, the writer, to enrich the readers and thus would be failing in his duties to readers if he did not confirm the submission relating to the fundamental capital gains tax differences for paragraph (a) special trusts and paragraph (b) special trusts. Simply put – in the Eighth Schedule a “special trust” is clearly defined as a trust contemplated in paragraph (a) of section 1. The rest follows from that definition i.e. the fact that a paragraph (b) special trust is not included (the rationale for such exclusion is considered to be sound).
The writer continues to recommend paragraph (a) special trusts to clients and prospective clients. Bendels Consulting is a niche tax practice which specialises exclusively on tax and medical related issues. Based on the writers medical research and experience, there are several thousand taxpayers (and their families) who would benefit substantially from a properly created paragraph (a) special trust.
Another small “sugar coated pill”.
All material subject to our Legal Disclaimers.