What Determines a Trust’s Tax Liability?
31 March 2011
Posted by: TaxFind™
What Determines a Trust’s Tax Liability?
The law, or the trust deed?
A trust deed is a contractual arrangement that regulates the right of persons (beneficiaries) to participate in the income and capital administered by trustees for their benefit.
It is not uncommon for a trust deed to say, for example, that the trustees can determine which trust incomings and outgoings will be treated as capital, and which will be treated as revenue.The trust deed may also say, for example, that the trust's revenue or capital losses of prior years are to be recouped before any income or capital distribution can be made to beneficiaries in the current year.
Where a trust deed contains such provisions, what account, if any must SARS take of them in determining the taxable income of the trust and the trust beneficiaries?No reported decision of the South African courts has yet addressed these issues, but some guidance can be derived from the decision of Australia's Full Federal Court in the case of Cajkusic v Commissioner of Taxation  64 ATR 676. Of course, decisions of foreign courts must be treated with caution because of differences in statutory and non-statutory tax principles between various jurisdictions.
The Australian law of trusts is based on English law. So too, to a considerable extent, is South Africa's law of trusts, but our trust law has gone through a process of evolution and is now a South African institution that has drawn on the jurisprudence of several countries, but which has also developed distinct and unique home-grown features.
In both Australia and South Africa, trust income is taxed either in the trust itself, or in the hands of the trust beneficiaries, but the same income is not taxed in the hands of both. Thus, if it is not taxable in the hands of the beneficiaries, the trust income is necessarily taxable in the hands of the trust.
The decision in Cajkusic v Commissioner of Taxation concerned a family trust. Its income tax return for the 1998 tax year reflected nil net income.However, the Australian tax authorities disallowed certain deductions claimed by the trust and certain prior year losses carried forward by the trust, with the result that the trust had a net income of some $225 000 for the year.
The trust deed provided that the trust beneficiaries were "default income beneficiaries”, meaning that if the trustees passed no contrary resolution, the beneficiaries would be entitled to the trust's net income for the year.No such contrary resolution was in fact passed for the year in issue in this case.The Australian tax authorities therefore included the $225 000 income of the trust in the assessable income of the trust beneficiaries.The latter objected to the assessment.The question before the court was whether, on the facts as outlined above, there was any trust income to which the trust beneficiaries were entitled in the1998 tax year, given the lack of any contrary resolution by the trustees and the default rights of the beneficiaries.
If effect were to be given to the decision of the trustees, taken in terms of their powers under the trust deed, to regard certain expenditure as deductible and to recoup prior years' losses, then the trust would have no income in the tax year that was distributable to beneficiaries.It followed that if any tax was payable on trust income, it would be payable by the trust, not by the beneficiaries.
On the other hand, if effect were to be given to the tax legislation in terms of which the trust did indeed have a taxable income because the expenditure claimed as a deduction was not deductible, and in terms of which the trust's prior losses could not be carried forward, and if effect were also given to the provision in the trust deed that, in default of any contrary resolution by the trustees,the trust beneficiaries were entitled to the trust's net income for the year, then the trust's income for the year would be taxable in the hands of the beneficiaries.
The full Federal Court ruled that the trust did not have any distributable net income in the 1998 tax year. This was because the trustees, in accordance with their powers under the trust deed, had treated certain outgoings as being deductible for income tax purposes and (again in accordance with the requirements of the trust deed) had set off certain prior year losses against the trust's current year income.Consequently, said the court, there was—in terms of the trust deed—no trust income to which the trust beneficiaries were entitled in the 1998 tax year.The trust's taxable income (determined in accordance with tax legislation,as distinct from the provisions of the trust deed) must therefore necessarily be taxable in the trust.
This article first appeared in "Synopsis”, PricewaterhouseCoopers’ in-house tax publication.
Source: By PricewaterhouseCoopers (Tax breaks)