Tax incentives or reliefs associated with the registration of a family trust

In the realm of family wealth preservation, there exists an ancient Chinese proverb which posits that family wealth seldom persists beyond three generations. According to this adage, the initial generation builds wealth, the second safeguards it, and the third, having had no hand in its creation, tends to dissipate it. It might be reasonable to conclude that, in many instances, wealth may not even reach the third generation.

This adage underpins the creation of family trusts – structures designed to manage and safeguard assets for the purpose of ensuring wealth continuity and the seamless passage of wealth through generations.

In simple terms, a trust exists when a person (settlor) transfers control of property to another person (trustee) to hold for the benefit of the beneficiaries. This trust structure serves as a means of succession planning and asset protection, enabling the settlor to pass assets from one generation to the next while allowing trustees to identify the future needs and requirements of the beneficiaries.

Globally, family trusts are commonly recognised as tax planning structures due to the tax incentives designed to accompany them. In Kenya, the Income Tax Act has undergone frequent amendments to address trust income, deemed income of trustees, and beneficiaries. However, a critical question arises: do these amendments provide sufficient incentives for the registration of family trusts?

In contrast to Kenya, the United Kingdom (UK) government acknowledges the societal importance of family trusts, viewing them as legitimate structures for citizens to manage their business and personal affairs. Accordingly, the UK has established proper tax structures for the taxation of trusts without resorting to artificial incentives for trust creation.

Regrettably, many jurisdictions, including Kenya, often perceive trusts as tools for tax avoidance rather than essential components of estate and succession planning. This misguided perception has led to a myriad of legislative amendments in the taxation of trusts, resulting in a lack of a uniform, coherent, and consistent trust taxation system.

So, what tax incentives are available when utilising a registered family trust? In addition to the exemption of stamp duty and capital gains tax for property transfers to a trust, one might be interested in exploring additional tax incentives or reliefs associated with the registration of a family trust.

It's crucial to note that taxation of trusts is provided for under Section 11 of the Income Tax Act. This section stipulates that all income, ordinarily subject to income tax, is deemed to be the income of the trustee, executor, or administrator of the trust hence taxable at the hands of the trustees.

In practical terms, when income is generated by assets held by the trustees, as is the case with discretionary trusts, the trustees are liable to income tax on this undistributed income. Secondly, if a beneficiary is entitled, under the trust, to an income, that income is directly taxable on the beneficiary.

It is crucial for individuals to understand the potential tax implications associated with trust registration. Understanding how to design or structure a trust can enable one to leverage specific tax reliefs outlined within the Income Tax Act.

Baston Woodland is an advocate of the High Court of Kenya.