Taxation of donors and beneficiaries of trusts
16 Jul 2020
With effect from 1 March 2019, significant changes were made to the Income Tax Act relating to the taxation of offshore trusts and distributions made to South African resident beneficiaries. The legislative amendments were prompted to curb the use of the offshore trust as a shield from tax in South Africa. In the Explanatory Memorandum it was indicated that Government has, since 2008, been concerned that the Controlled Foreign Company (CFC) rules do not capture foreign companies held by interposed foreign trusts.
To address this perceived loophole, the measures introduced preclude reliance on the participation exemption that is granted where an offshore trust holds more than 50% of the shares in an offshore company or has more than 50% of the voting rights in an offshore company. Effectively, any distributions from such an offshore trust to a South African beneficiary become taxable either as income or capital depending on the nature of the distribution. Additionally, any donor to such an offshore trust will also not be able to rely on the participation exemption in relating to the attribution of income as a result of the donation to establish the offshore trust.
These changes mean that donors and beneficiaries of an offshore trust need to take cognisance if the underlying assets, the timing of any receipts and the nature of receipts.
Most recently, the South African Revenue Service has issued a draft interpretation note for comment regarding the interaction between the so-called attribution rules contained in section 7(8) and the vesting provisions of section 25B. In terms of the attribution rules, a donor who establishes an offshore trust is obliged to account for the income earned by that offshore trust as a result of the initial donation made to such offshore trust. South African beneficiaries of an offshore trust are also obliged in certain instances to account for the income or capital receipt upon any distribution by a trust.
This interpretation note seeks to clarify which provision (section 7(8)) or section 25B(1)) applies when income received by or accrued to a non-resident trust by reason of or in consequence of a donation, settlement or other disposition by a resident, is vested in a resident beneficiary by the trustees of the non-resident trust.
A conflict may arise because the amount is potentially economically taxed twice given that –
- section 25B(1) 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.
It is stated in the draft interpretation note that 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.
Practically, 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. The draft interpretation note does not make it clear as to the mechanism for proving that there is an obligation on the part of the donor. Additionally, it is unclear as to what would be the position where the tax returns cannot be reconciled such as the case where there has been no declaration by the donor but a subsequent declaration by the beneficiary. It is therefore important to confirm the position of both the donor and the beneficiary in completing any tax return.
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