This article deals with the issue of whether double taxation can occur; i.e. the trust and the beneficiary both pay tax. Definitions, explanations and clauses from the Income Tax Act are plentiful in this article; please be prepared for a lengthy discussion.
A trustee is the representative taxpayer of a trust. The income of a trust may, depending on the circumstances be taxed in the hands of the following:
Where the trust itself is taxed, it is taxed at a flat rate of 45%. Special trusts are taxed on a sliding scale from 18% to 45% (same as natural persons).
There are a number of ways in which trusts in South Africa can be classified.
An “ownership trust”, the founder or settlor transfers ownership of assets or property to a trustee(s) (in a fiduciary capacity) to be held for the benefit of defined or determinable beneficiaries of the trust.
A “bewind trust”, the founder or settlor transfers ownership of assets or property to beneficiaries of the trust, but control over the assets or property, is given to the trustee(s).
An “inter vivos trust” is created during the lifetime of a person by way of an agreement (contract) between the founder and the trustee(s).
A “testamentary trust” is set up in terms of the will of a person and comes into effect after their death.
A “vesting trust” – trusts where income, capital gains or assets are vested to a beneficiary in terms of the trust instrument.
A “discretionary trust” – a trust where the trustee(s) in terms of the trust instrument, has the right to vest income, capital gains, assets or retained amounts in that trust, to its beneficiaries.
A “hybrid trust” – the majority of trusts in South Africa will have vested and contingent rights provided for in the trust instrument. In other words, a combination of the vesting trust and the discretionary trust mentioned above.
Specific application trusts – trusts may be classified as a type of trust based on the application of the trust.
Trading (Business) trusts
Asset-protection or realisation trusts
Land rehabilitation trusts
Share incentive scheme trusts
Collective investment scheme (CIS) trusts
For tax purposes the following types of special trusts are recognised:
Special Trust Type A – a trust created solely for the benefit of a person(s) with a mental or physical “disability” as defined in section 6B(1) of the Act.
Special Trust Type B – a trust created solely for the benefit of a person(s) who is a relative of the person who died and who are alive on the date of death of that deceased person (including those conceived but not yet born), and the youngest of the beneficiaries is younger than 18 years on the last day of the year of assessment.
The various ways of describing trusts or trust types are not mutually exclusive. For example, an inter vivos trust can technically be both a Special Trust Type A and an Inter Vivos Trust; and a Testamentary Trust can be both a Special Trust Type B and a Testamentary Trust. However, from a tax perspective, approved (and qualifying) Special Trusts are taxed differently than normal Inter Vivos and Testamentary Trusts, and it is recommended that the relevant approved (and qualifying) Special Trust should be disclosed as the Trust Type when completing the tax return.
All trusts need to register with SARS.
Trusts do not qualify for any of the rebates provided for in Section 6 of the Income Tax Act.
In order to claim the benefits applicable to a Special Trust Type A (for example relief from Capital Gains Tax under certain circumstances), the trustees should apply at a SARS branch for classification.
From the tax law; clauses and definitions:
Section 25B – Income of trusts and beneficiaries of trusts
(1) Any amount received by or accrued to or in favour of any person during any year of assessment in his or her capacity as the trustee of a trust, shall, subject to the provisions of section 7, to the extent to which that amount has been derived for the immediate or future benefit of any ascertained beneficiary who has a vested right to that amount during that year, be deemed to be an amount which has accrued to that beneficiary, and to the extent to which that amount is not so derived, be deemed to be an amount which has accrued to that trust.
(2) Where a beneficiary has acquired a vested right to any amount referred to in subsection (1) in consequence of the exercise by the trustee of a discretion vested in him or her in terms of the relevant deed of trust, agreement or will of a deceased person, that amount shall for the purposes of that subsection be deemed to have been derived for the benefit of that beneficiary.
(2A) Where during any year of assessment any resident acquires any vested right to any amount representing capital of any trust which is not a resident, that amount must be included in the income of that resident in that year, if:
(a) that capital arose from any receipts and accruals of such trust which would have constituted income if such trust had been a resident, in any previous year of assessment during which that resident had a contingent right to that amount; and
(b) that amount has not been subject to tax in the Republic in terms of this Act.
(3) Any deduction or allowance which may be made under the provisions of this Act in the determination of the taxable income derived by way of any amount referred to in subsection (1), must, to the extent to which that amount is under that subsection deemed to be an amount which has accrued to:
(a) a beneficiary, be deemed to be a deduction or allowance which may be made in the determination of the taxable income derived by that beneficiary; and
(b) the trust, be deemed to be a deduction or allowance which may be made in the determination of the taxable income derived by that trust.
(4) The deduction or allowance contemplated in subsection (3) which is deemed to be made in the determination of the taxable income of a beneficiary of a trust during any year of assessment, shall be limited to so much of the amount deemed to have been received by or accrued to that beneficiary in terms of subsection (1), as is included in the income of that beneficiary during that year of assessment.
(5) The amount by which the sum of the deductions and allowances contemplated in subsection (4) exceeds the amount included in the income of the beneficiary during a year of assessment as contemplated in that subsection:
(a) is deemed to be a deduction or allowance which may be made in the determination of the taxable income of the trust during that year: provided that the sum of those deductions and allowances shall be limited to the taxable income of that trust during that year of assessment as calculated before allowing any deduction or allowance under this subsection; or
(b) where the trust is not subject to tax in the Republic, must be carried forward and be deemed to be a deduction or allowance which may be made in the determination of the taxable income derived by that beneficiary by way of amounts referred to in subsection (1) during the immediately succeeding year of assessment.
(6) The amount by which the sum of the deductions and allowances contemplated in subsection (4) exceeds the sum of the amount included in the income of the beneficiary as contemplated in subsection (4) and the taxable income of the trust as contemplated in subsection (5) (a), must be deemed to be a deduction or allowance for purposes of subsection (3), which may be made in the determination of the taxable income derived by that beneficiary by way of any amount referred to in subsection (1) during the immediately succeeding year of assessment.
(7) Subsections (4), (5) and (6) do not apply in respect of any amount which is deemed to have accrued to any beneficiary in terms of subsection (1), where that beneficiary is not subject to tax in the Republic on that amount.
Adding on to clause 7, is sub-section 8 related to residents and their tax obligation (“When income is deemed to have been accrued or to have been received”)…
(8) Where by reason of or in consequence of any donation, settlement or other disposition (other than a donation, settlement or other disposition to an entity which is not a resident and which is similar to a public benefit organisation contemplated in section 30) made by any resident, any amount is received by or accrued to any person who is not a resident (other than a controlled foreign company in relation to such resident), which would have constituted income had that person been a resident, there shall be included in the income of that resident so much of that amount as is attributable to that donation, settlement or other disposition.
The question that probably arises is “what does this all mean?”. The issue is whether double taxation can occur; i.e. the trust and the beneficiary both pay tax.
Section 25B(1) of the Act deems the amount vested in the beneficiary to have accrued to the resident beneficiary and therefore it would be included in the resident beneficiary’s gross income; and
section 7(8) requires that any income received by or accrued to the non-resident trust be included in the donor’s income.
The effect of the words “subject to the provisions of section 7” in section 25B(1) is that if there is a conflict, inconsistency or incompatibility between section 25B(1) and section 7(8), section 7(8) is given dominance and will prevail. In other words, to the extent that the income has been attributed to the donor, it is not taken into account by a resident beneficiary in whom it has been vested.
The question which arises is how the donor and the beneficiary will account for the relevant amounts in their respective income tax returns to demonstrate that the tax has been borne by the donor in a case where section 7(8) prevails. It is important to confirm the position of both the donor and the beneficiary in completing any tax return.
In South Africa, Tax Court cases dealing with taxation of a trust and the beneficiaries have arisen and the outcome thereof provide a clear understanding of the tax interpretation for these cases. Distributing the gains from the trust is the case in point.
The “conduit principle” with regard to trusts is something to take note of. Income or gains that are realised inside a trust, can “flow through”, or be distributed to the beneficiaries of the trust, while retaining the nature of the income.
This means that dividends received get passed on as dividends and taxed as dividends, that interest earned and distributed gets taxed as interest, and that capital gains that are distributed get taxed as capital gains. These amounts are then taxed in the hands of the beneficiaries and NOT the trust. The fact that the nature of the income is also retained is very important, as natural persons receive certain exemptions, exclusions and/or rebates on certain items and get taxed differently.
In terms of paragraph 80 of the Eighth Schedule of the Income Tax Act, where a capital gain is vested in a beneficiary of the trust, the trust will not have that gain included in its own tax calculation, but it will be taxed in the hands of the beneficiary.
This means that where a trust deed authorises the trustees to do so, the trustees are able to distribute the capital gains of the trusts, vesting it in the beneficiaries. It is also possible to distribute the gains to multiple beneficiaries, each paying at their assumed lower marginal tax rate and each having their own annual exclusion amount. Substantial capital gains tax savings can thereby be achieved.
It is important to keep in mind that to achieve savings of this nature, the capital gain has to be allocated to a resident natural person in the year in which it was realised by the trust. Many trusts have beneficiaries that include another trust. If the gain passes to another trust first and then to an ultimate beneficiary of the second trust, the higher effective tax rate applies.
From Section 26B of the Income Tax Act, taxable capital gains – which are to be included in a taxpayer’s taxable income – are to be determined in terms of the Eighth Schedule to the Act.
Paragraph 80 of the Eighth Schedule deals with the attribution of a trust’s capital gains to its beneficiaries. A distinction is drawn in paragraphs 80(1) and 80(2) between capital gains determined in respect of the vesting by a trust of an asset in a beneficiary, and capital gains determined in respect of the disposal of an asset by a trust, where the beneficiary has a vested interest in the capital gain but not in the asset in respect of which the capital gain was derived.
In either of the aforementioned circumstances the capital gain must be disregarded for the purposes of calculating the trust’s taxable income, and must be taken into account when calculating the taxable income of the trust beneficiary in whom the capital gain vests.
On 20 January 2021, an amendment to section 25B(1) was promulgated to the effect that the previously wide concept of “any amount” as contemplated in this subsection has now been qualified to exclude “amount[s] of a capital nature which [are] not included in gross income or an amount contemplated in paragraph 3B of the Second Schedule”.
The Tax Court stated that the impact of this amendment would be to trap certain capital gains and lump sums in the trust in order to ensure that they are taxed in the trust rather than in the hands of the beneficiaries of the trust. The attribution of the capital gains of a trust to its beneficiaries is specifically dealt with in paragraph 80 of the Eighth Schedule.
All things considered, taxation of a trust and the beneficiaries depend on the mechanisms and structures involved; use of the “conduit principle” with regard to trusts is something to take note of.
Income or gains that are realised inside a trust
Author Craig Tonkin