Know The Possible Limitations When Setting up a Business Trust
A business trust is often used as a tool for managing and protecting business assets, especially in South Africa, where entrepreneurs are always looking for ways to safeguard their wealth and ensure smooth succession planning. While a business trust can offer numerous advantages, such as asset protection, tax benefits, and the ability to separate personal and business assets, there are several key disadvantages to consider before opting for this structure.
1. Complexity and Administrative Burden
One of the most significant disadvantages of a business trust is the complexity and administrative burden involved in setting it up and maintaining it. Unlike a traditional company structure, a trust requires careful legal documentation, proper registration, and the appointment of trustees who must adhere to fiduciary duties.
This includes:
- Drafting a Trust Deed: The trust deed must clearly outline the objectives, roles of the trustees, and distribution of assets. A poorly drafted deed can lead to confusion or disputes in the future.
- Trustee Management: Trustees are legally responsible for managing the assets within the trust in the best interest of the beneficiaries. This can create a burden on trustees, who must comply with strict regulations, such as keeping accurate records, filing tax returns, and holding regular meetings. For business owners, this can mean more paperwork, additional oversight, and potentially hiring professionals to manage the trust.
- Cost of Administration: Setting up and maintaining a business trust can be costly, especially when considering the need for professional services such as legal, accounting, and tax advice. Over time, these costs can add up, particularly if the trust holds substantial assets.
2. Loss of Control Over Business Assets
When assets are transferred to a business trust, the individual business owner loses direct control over them. The trustee assumes control, and although the settlor (the person who creates the trust) can specify the terms of the trust, they no longer have full ownership or decision-making authority over the business.
This lack of control can be problematic in certain business contexts, especially for entrepreneurs who are accustomed to making quick decisions or taking risks. While the trustees are required to act in the best interests of the beneficiaries, this can lead to conflicts if their approach to managing the business assets differs from that of the original owner.
Additionally, if the trust becomes the legal owner of business assets, personal decisions regarding these assets may no longer be possible without trustee approval, which can create delays or administrative challenges.
3. Tax Implications and Administrative Complexity
While business trusts offer potential tax benefits, they also come with tax obligations that need careful consideration. For example, the trust is required to file separate tax returns, and the tax rates for trusts in South Africa can be quite high compared to individual tax rates.
- Income Tax: If the trust retains income instead of distributing it to beneficiaries, it will be taxed at the maximum rate of 45%. This high rate makes it less tax-efficient to retain income within the trust. Therefore, business owners must carefully manage how income is distributed to beneficiaries to avoid paying high taxes.
- Capital Gains Tax (CGT): When assets are sold or transferred from the trust, CGT applies at a higher rate (36%) for trusts compared to individuals. This can lead to an increased tax liability on any capital gains made by the business trust.
- Complex Tax Filing: A business trust is required to file annual tax returns, and the tax administration for trusts can be more complex compared to a standard company. Business owners may find themselves needing to hire tax professionals to ensure compliance with tax laws and avoid penalties.
4. Potential for Family Disputes
A business trust, particularly when used to pass assets onto family members or manage a family business, can lead to disagreements or disputes. Since trustees are required to act in the best interests of the beneficiaries, tensions can arise if there is a lack of clarity in the trust deed or differing opinions on how the business should be run.
For example, if the beneficiaries are family members who have conflicting views on the direction of the business, this can create significant family drama. Additionally, if a trustee is perceived to be acting in their own interest rather than in the best interest of the beneficiaries, this could lead to legal disputes or challenges to the trust’s decisions.
Clear communication, a well-drafted trust deed, and selecting trustworthy and competent trustees are essential to minimizing the potential for conflict.
5. Limited Flexibility in Decision-Making
A business trust is governed by the terms of the trust deed, which means it can be less flexible than other business structures. Business owners who wish to make changes to the structure or operations of the business may find that any modifications require the approval of the trustees, or even the beneficiaries, depending on the trust’s specific provisions.
This lack of flexibility can be frustrating for business owners, particularly if there is a need for quick adjustments or strategic changes. Furthermore, once assets are placed in the trust, it can be difficult and costly to remove them, especially if the trust is designed to protect those assets for the long term.
6. Risk of Legal and Compliance Issues
Like all legal entities, business trusts must comply with the relevant laws and regulations, and failure to do so can lead to serious legal and financial consequences. In South Africa, business trusts are subject to laws governing trustees’ fiduciary duties, tax laws, and the governance of trusts. Any failure to comply with these laws, whether intentional or accidental, can result in penalties or even the invalidation of the trust.
The risk of non-compliance may also be heightened if trustees are not familiar with the relevant legal requirements or fail to keep up with changing regulations. It is essential to ensure that trustees are properly educated and supported in order to avoid potential pitfalls.
7. Limited Access to Certain Tax Benefits
While business trusts can provide some tax benefits, such as income splitting or estate duty reduction, they do not offer all of the tax advantages that other business structures may provide. For example, companies in South Africa may benefit from lower tax rates on profits (currently 28%) compared to the higher rates applicable to trusts.
Additionally, tax advantages related to business expenses, deductions, or reinvestment of profits may not be as easily available to a trust as they would be for a sole proprietor or a company. Business owners must weigh these considerations against the benefits when deciding on the most appropriate structure.
A business trust can be a powerful tool for asset protection, estate planning, and wealth management in South Africa. However, it is important to carefully consider the potential disadvantages, including complexity, loss of control, high tax rates, and the risk of family disputes.
At Burger Huyser Attorneys, we specialise in advising clients on the pros and cons of different business structures, including business trusts. If you are considering a business trust for your enterprise or need guidance on structuring your business assets, contact us today. Our experienced team will provide personalized advice to help you make the best decision for your business, ensuring it aligns with your long-term goals and financial objectives.
Contact Burger Huyser Attorneys, and book a consultation.
To speak to one of our experienced attorneys in South Africa for immediate assistance, contact us on the numbers below:
Randburg call 061 516 6878; Roodepoort call 061 516 0091; Sandton call 064 555 3358;  Pretoria call 064 548 4838;
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DISCLAIMER: Information provided in this article does not, and is not intended to constitute legal advice. READ MORE
