Taxation of trusts to be revisited
27 October 2015
Posted by: Author: Hanneke Farrand
Author: Hanneke Farrand (ENS)
recent Davis Committee Report on Estate Duty has revealed that SARS is
concerned with the use of trusts for tax planning purposes.
Davis Tax Committee First Interim Report on Estate Duty (DTC Report) was
released for public comment on 13 July 2015. The DTC Report, in essence,
proposes that "many deficiencies of the current estate duty system be addressed
by way of…simple yet fundamental amendments to the existing legislation.”
DTC Report deals, among others, with donations tax, estate duty and the
taxation of trusts. We set out below our comments on the recommendations made
in the DTC Report insofar as they are applicable to trusts.
is clear from the DTC Report that SARS is concerned with the use of trusts for
tax planning purposes and, in particular, in the context of estate planning.
recommendations in the DTC Report are subject to consultation and will not
necessarily find their way into draft tax legislation. In this regard, the DTC
Report specifically states that, "the repeal of the attribution provisions will
have diverse and far-reaching implications... An extensive consultative process
will have to follow … to identify and address the many issues involved.”
Broomberg on Tax Strategy it is stated that:
"The common assumption is that trusts are some
kind of tax panacea... Then, conversely, from a…SARS…perspective trusts are
viewed with a degree of suspicion and mistrust. [T]he truth lies somewhere
between these positions. Trusts are useful vehicles, but there is little tax
magic that arises from the utilisation of a trust.”
Africa has well established rules and case law dealing with the taxation of
trusts. SARS also recently introduced new tax returns for trusts that require
far more detailed disclosures by taxpayers in accordance with these principles.
It is hoped that the fact that these mechanisms are currently available will be
considered during the extensive consultative process and that solutions can be
found to the issues identified in the DTC Report without adopting all the
proposed tax measures.
General principles relating
to the taxation of trusts
terms of South African tax law, essentially, two different types of trusts
exist, namely a vesting trust and a discretionary trust. A vesting trust is a
trust in which the beneficiary has a vested right to the income and/or capital
thereof, i.e. the beneficiary has a right to trust distributions which cannot
be defeated, and such right passes to his cessionaries or his estate upon his
death even if the distribution is payable at some future date.
discretionary trust does not provide a beneficiary with a vested right to trust
distributions. Instead, the trustees have a discretion to make distributions to
beneficiaries. Section 25B of the Income Tax Act No. 58 of 1962 (Income Tax
Act), read together with section 7(1), essentially codified the conduit-pipe
principle first articulated in South African common law. In this regard, income
received by or accrued to a vesting trust is taxed in the hands of the vested
beneficiary/ies, i.e. the trust is transparent for tax purposes. On the other
hand, income received by or accrued to a discretionary trust will be taxed in
the hands of the trust, unless it is distributed to a beneficiary before the
fiscal year end of the trust, in which case it will be taxed in the
above income tax consequences may, however, be superseded by the deeming
provisions relating to trust income as set out in section 7 of the Income Tax
Act. In this regard, where any person (including a South African tax resident)
makes a gratuitous disposal to a domestic trust which is subject to a condition
or stipulation which provides that the beneficiaries may not receive the income
(or a portion thereof) until the happening of some event, section 7(5) may
attribute the retained income derived by the trust from such gratuitous
disposition to that person until the happening of the event or the death of
that person, whichever first takes place. It is accepted that the exercise of
their discretion by the trustees of a discretionary trust is regarded as being
an "event” for purposes of this section.
trust income is taxed in the hands of the trust, on subsequent distribution to
a beneficiary, such distribution is treated as capital in the hands of the
the context of capital gains tax (CGT), the Eighth Schedule to the Income Tax Act
contains similar attribution rules which attribute capital gains to the donor
or settlor of a trust or to resident beneficiaries.
paragraph 70 deals with capital gains retained in the trust and is worded
similarly to section 7(5). In this regard, where any person (including a South
African tax resident) makes a gratuitous disposal to a domestic trust which is
subject to a stipulation or condition which provides that the capital gain (or
a portion thereof) attributable to such gratuitous disposal shall not vest in
the beneficiaries until the happening of some fixed or contingent event,
paragraph 70 may attribute the retained capital gains attributable to such
gratuitous disposition to that person if the capital gains has arisen during a tax
year throughout which the person has been a resident and the capital gain has
not vested during that year in any resident beneficiary. The exercise of their
discretion by the trustees of a discretionary trust will also be regarded as
being an "event” for purposes of this paragraph.
terms of paragraph 80(2) of the Eighth Schedule to the Income Tax Act, in the
event that the trust sells an asset and makes a capital gain, such gain will be
taxed in the hands of the South African resident beneficiary if the gain (or a
portion thereof) is vested in that beneficiary in the same tax year that it
arises. In the event that the gain is vested in a non-resident beneficiary, the
trust will be taxed on that capital gain.
a South African resident made a gratuitous disposal to any person (including a
South African trust) and a capital gain attributable to that gratuitous
disposal has arisen during a year of assessment and has during that year vested
in or is treated as having vested in any person who is not a resident, that
capital gain will be attributable to that resident in terms of paragraph 72 of
the Eighth Schedule to the income Tax Act.
is also a third trust type, i.e. the so-called bewind trust. In a bewind trust,
ownership of the trust property vests in the beneficiary/ies. However, the
trustees administer and control the trust property. Therefore, any income or
capital gain arising by virtue of the use or disposal of the trust property
will automatically vest in the beneficiary/ies and such income or capital gains
will not be taxed in the trust.
Recommendations in the DTC
DTC recommends, inter alia, that the following amendments be made to the
existing tax legislation:
flat rate of tax for trusts should be maintained at its existing level (i.e. 41
provisions in terms of which trust income of South African resident trusts can
be taxed in the hands of beneficiaries or a donor at individual marginal tax
rates as opposed to the higher flat rate of tax in a trust, should be removed.
This means that trust income will always be taxed at the flat rate of tax
applicable to trusts
attribution and distribution rules pertaining to offshore trusts should be
retained. However, all distributions of foreign trusts to South African
resident beneficiaries should be taxed as income
should be taxed as separate taxpayers.
attempt should be made to implement transfer pricing adjustments in the event
of financial assistance or interest-free loans being advanced to trusts.
is unclear from the DTC Report whether this recommendation is made in respect
of all trust types, including a bewind trust. In that instance, this
recommendation would, effectively, result in the bewind trust being liable for
tax on income and/or capital merely flowing through such trusts by virtue of
the assets it administers and controls for the benefit of its beneficiaries.
is not specifically recommended in the DTC Report that the provisions in terms
of which capital gains of South African resident trusts may be taxed in the
hands of beneficiaries or a donor at lower individual marginal tax rate as
opposed to the higher rate of tax in a trust, should be removed.
Offshore trust distributions
recommendation in the DTC Report that all offshore trust distributions should
be taxed as income does not take into account the distinction between income
and capital receipts. Repayments of loans or distributions of the original
corpus of an offshore trust, in our view, should not be regarded as income
distributions since such distributions should retain their nature as "capital”.
our view, the rules applicable to the taxation of trust income and capital
gains distributed by offshore trusts to South African resident beneficiaries
are clear and can be substantiated if proper financial records are kept. To
this end, the taxpayer carries the onus of proof to provide adequate records to
substantiate the nature of the distributions. SARS could tax distributions from
offshore trusts as income if the taxpayer could not prove that the distribution
was made from the original capital or capital gains. Simply taxing all
distributions from offshore trusts would have far-reaching and, in our view,
unnecessary tax implications for South African resident beneficiaries.
is unclear how this recommendation would be implemented in practice taking into
account the fact that, as mentioned above, South Africa has well established
rules and case law dealing with the taxation of trusts. For example, how would
distributions from a trust to its beneficiaries be treated for tax purposes in
the event that all trusts are treated as separate taxpayers i.e. would they be
deductible in the hands of the trust and/or subject to withholding tax in the
hands of the beneficiaries?
transfer pricing rules are applicable to "affected transactions” (as defined) which,
essentially, mean that such rules are only applicable in a cross-border context.
Therefore, as noted in the DTC Report, the transfer pricing rules are not
applicable to loans between South African resident taxpayers. In the event that
the recommendation relating to the removal of the income attribution rules,
insofar as they apply to South African trusts, is implemented, all trust income
will in any event be taxed in the South African trust.
Corporate use of trusts
are not only used by individuals. In the corporate sphere, trusts are used to
facilitate a portfolio of investments, for example, a collective investments
scheme. These are not specifically dealt with in the DTC Report, although it is
stated that taxpayers must be allowed to make use of trusts when it makes sound
sense to do so in the pursuit of a commercial benefit, as opposed to an estate
duty benefit. A broad-brush amendment of established trust principles would,
however, also impact these arrangements.
the recommendations contained in the DTC Report are implemented, then all South
African resident trusts will be taxed as separate taxpayers. They will be taxed
on income at a flat rate of 41 per cent and on capital gains at an effective
rate of 27.31 per cent.
the scope of the legislative amendments to the tax treatment of trusts has been
finalised, in our view, a period should be allowed for taxpayers to re-evaluate
their interests and determine whether to continue with the current trust
arrangement or to dissolve same prior to the implementation of the
recommendations in the DTC Report.
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This article first appeared on the September/October 2015 edition on Tax Talk.