SA trusts and non-resident beneficiaries: proposal to address tax avoidance

The recent Supreme Court of Appeal judgment in CSARS v Thistle Trust (516/2021) [2022] ZASCA 153 (7 November 2022) has highlighted the interpretive challenges that section 25B of the ITA and Paragraph 80 of the Eighth Schedule to the ITA, both applicable to trusts, can create. Now the Minister proposes addressing an apparent inconsistency resulting from the application of these provisions.

2 Mar 2023 3 min read Special Edition Budget Speech Alert Article

At a glance

  • The recent Supreme Court of Appeal judgment in CSARS v Thistle Trust highlighted an inconsistency in the application of section 25B and Paragraph 80 of the Eighth Schedule to the ITA, both applicable to trusts.
  • Paragraph 80 distinguishes between residents and non-residents, attributing capital gains to resident beneficiaries and taxing them in the trust's hands. Section 25B, on the other hand, does not make this distinction.
  • The Budget proposes amending section 25B to align it with the interpretation of Paragraph 80, potentially subjecting non-resident beneficiaries to higher taxation rates imposed on the trust's income. The amendment's impact will be significant if implemented.

Paragraph 80 of the Eighth Schedule deals with the vesting of an asset by a local South African trust to a beneficiary with the effect being that when an asset is vested by a South African trust into a resident beneficiary, the capital gain flowing from this will be attributable to the resident beneficiary. This capital gain will (in the hands of the trust) be disregarded for purposes of calculating the total capital gain or loss. On the other side of this, the Budget expresses the view (similar to what is stated in SARS’ Comprehensive Guide on Capital Gains Tax) (CGT Guide) that if an asset or gain is vested in a non-resident beneficiary, the result is that the capital gain flowing from that will not be attributable to the non-resident as an individual but to the trust and taxed in the South African trust’s hands. In other words, it would be taxed in South Africa at the effective rate of 36% and it is easier to ensure that the correct tax amount is paid to SARS. However, whereas Paragraph 80 distinguishes between residents and non-residents, section 25B contains no such distinction. Sections 25B(1) and (2) merely refer to the vesting of amounts in a “person” or a beneficiary but make no reference to the residence of such person or beneficiary.

Although section 25B contains anti-avoidance provisions, they apply to address anti-avoidance where funds are transferred to a foreign trust, with the income then being vested in resident or non-resident beneficiaries by the foreign trust. With the increase of such offshore trust structures and the Budget noting that the number of persons applying to make use of their foreign capital allowance increasing, it appears that the anti-avoidance provisions in section 25B generally address the risk of tax avoidance using foreign trusts. However, it appears that there is a concern that a South African trust vesting income in a non-resident beneficiary can create the risk of tax avoidance and challenges in collection. From a South African tax perspective, non-residents are only subject to tax in South Africa to the extent that the income is from a South African source. Therefore, if South African source income is vested by the South African trust in a non-resident beneficiary, such as rental income, for example, the non-resident would need to declare such rental income in a tax return to SARS and would be taxed according to the personal income tax tables. However, as section 25B does not distinguish between residents and non-residents, it is possible that in practice, the South African trust can vest South African source income in the non-resident beneficiary, but which such beneficiary does not declare to SARS. Although SARS can take steps to collect the tax owing, including by requesting the assistance of the tax authority of the country where the non-resident resides, as provided for under some double tax agreements, it is more difficult to collect it. The Tax Administration Act 28 of 2011 does also make provision for SARS to take steps to collect tax from such non-resident beneficiaries, with the assistance of a foreign tax authority.

Amending section 25B

Therefore, the Budget proposes that section 25B be amended so that it applies in a similar way to how Paragraph 80 is interpreted according to the CGT Guide. If that is the intention, it is possible that a South African trust would be taxed on the income at the rate of 45% where income is vested in the non-resident beneficiary, as opposed to being taxed in accordance with the marginal tax rates applicable to individuals. The tax payable would be far higher as only an individual’s income in the top marginal income tax bracket is subject to 45%. If this is the way in which the amendment applies, only dividends earned by the South African trust from a South African resident company, would not be adversely affected. This is because the dividends withholding tax rate of 20% applies equally to dividends paid to South African resident and South African trust shareholders and is not affected by subsequent vesting.

The potential effects of this amendment, depending on how it is implemented (if implemented), will be far-reaching.

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