Trust Inter Vivos Shariah Characterization and Guidelines by Mr M S Omar

TRUST INTER VIVOS : SHARIAH CHARACTERIZATION AND GUIDELINES

1. A trust inter vivos (“the trust”) is essentially a lifetime arrangement, whereby the true founder transfers or delivers his or her asset/s to named trustees, appointed by him , to be held in trust, for the sole benefit of the designated beneficiaries, normally the spouse, children and descendants of the true founder, as is stipulated in the trust deed. The trust may be discretionary or vesting. It is discretionary when the appointed trustees, acting in a fiduciary capacity, are conferred the unfettered discretion to allocate income or capital to one or more beneficiaries selected from a defined group, in such proportions as they deem appropriate. The trust is vesting, when the specified beneficiaries enjoy a legal vested right to the income and capital of the trust in fixed proportions, as is specified in the trust deed.

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2. The trust is generally created to legitimately minimize estate duty and income tax, in accordance with the conduit principle : that is, any income vested to or accruing to a beneficiary within the same tax year , such income will retain its nature, and will be taxed in the hands of that beneficiary at his or her tax rates. In relation to estate duty saving, take the simple example : the founder buys a commercial property for 10 million rands. He transfers the property to a family trust. The property grows in value to 15 million rands, over a period of time. The additional growth in value of 5 million rands is a growth in the trust, and is accordingly exempt from estate duty. Similarly, the net income generated by the property, after providing for an acceptable market-related return on the founder’s loan account, is split between the beneficiaries in the books of the trust, thereby potentially significantly reducing income tax, which would otherwise have been paid at a much higher rate in the hands of the founder, if the trust was not created.

3. From a legal perspective, the essence of such a trust is that enjoyment and

control are functionally separate. The trust is for all practical purposes treated

as a separate ring fenced legal entity, although not regarded as a separate

legal person. It has been described as a legal institution sui generis. (see:

Braun v Blann and Botha NNO 1984 (2) SA 850 (A) at 859 E) The trustees have

no beneficial interest in the trust assets. They have a fiduciary responsibility to

act in the best interests of the beneficiaries, in accordance with the provisions

of the trust deed. They may be held liable for damages suffered by the

beneficiaries, in the case of misconduct, negligence or material breach of trust.

The Master of the High Court exercises supervision to restrict or prevent

abuses in terms of extensive powers under the Trust Property Control Act. The

Courts however exercise overriding jurisdiction to prevent abuse of the trust

form.

4. What then is the correct Shariah characterization of a trust inter vivos? It is

obvious that the trust inter vivos does not fall within the scope and ambit of a

recognized contract in Shariah, in terms of which ownership, and damaan (risk)

of the asset, constituting the underlying subject matter of the relevant

contract, passes from one person to another, subject to the conditions

governing the relevant contract. For example, in a contract of sale, ownership

of the specific asset (subject matter) passes from seller to buyer, immediately

upon conclusion of the contract, whilst the risk (damaan) in the asset only

passes from the seller to the buyer upon actual or constructive possession

thereof by the buyer. On the contrary, the founder ordinarily has no real

intention of unconditionally and absolutely transferring ownership of the asset,

which is, for convenience, held in the name of the trust for purposes of

effective estate planning and tax savings and benefits.

5. In substance, therefore, the trust is ordinarily, from a strict Shariah perspective, simply the alter ego of the founder, who exercises de facto control over the assets and activities of the trust. The trust represents a flexible special purpose vehicle designed to achieve optimal estate duty and tax benefits, unless there is clear evidence to the contrary to the effect that the true founder has entered into a prior Shariah compliant contract, in terms of which the trust is by consent used as a pure conduit to give effect to such Shariah compliant arrangement. Ultimately, the true founder retains overriding control via the board of trustees, of which he or she is a member, the remaining trustees simply give effect to the founder’s directions.

6. On this basis, applying substance over form, the true founder remains the real owner of the assets held or registered in the name of the trust, according to Shariah principles, unless there is clear and compelling evidence to the contrary, that the founder has transferred ownership of the underlying assets to the beneficiaries of the trust in terms of a prior recognized Shariah compliant contract, and consequently the beneficiaries as true owners have elected to use the trust as a conduit and vehicle to achieve optimal tax and estate duty benefits.

7. This means that, in the normal situation, the trust deed must be structured appropriately to ensure that, upon the death of the true founder, his or her assets, held nominally in the name of the trust, represented by capital and accrued income, must be distributed to the heirs of the true founder determined at the time of his or her death, strictly in accordance with, and in the proportions fixed by the Islamic Law of Succession.

8. The final question remains : how does one characterize the treatment of trust income which has been credited to, and legally vested in, the designated beneficiaries in the books of the trust, by the founder in his lifetime (acting through the board of trustees)? Should such legally vested amounts (reflected in the trust financials as loans owed by the trust to the specified beneficiaries) be treated as pure book entries for tax purposes, and be accordingly brought into account, upon the death of the founder, and redistributed at the relevant time amongst the founder’s heirs determined, at time of death, in accordance with the Islamic Law of Succession?

9. In my view, it is preferable to treat such past credited amounts of income, which have legally vested in a beneficiary, but have not been actually paid out, as a completed donation made by the founder to the relevant beneficiary/ recipient. The founder may however direct, in a side agreement, that all such credited amounts were in fact pure book entries for tax purposes, and must accordingly be brought into account and adjusted upon his death, to be redistributed amongst his prescribed heirs, in the proportions fixed by the Shariah.

AND ALLAH KNOWS BEST!

MAHOMED SHOAIB OMAR

DURBAN

Specialist Corporate and Shariah Attorney