The Taxation Laws Amendment Act 17 of 2023 made changes to s 25B(1) and (2) of the Income Tax Act 58 of 1962 (Act) that have profound tax implications for resident trusts with non-resident beneficiaries. The amendments apply to the 2025 and subsequent years of assessment and commenced on 1 March 2024.
Section 25B(1) and (2) now provide as follows:
'25B. Taxation of trusts and beneficiaries of trusts.—(1) Any amount (other than an amount of a capital nature which is not included in gross income or an amount contemplated in paragraph 3B of the Second Schedule) 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 is a resident and 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
who is a resident 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.'
(Underlining indicates the 2023 amendments.)
The
Explanatory Memorandum on the Taxation Laws Amendment bill, 2023 notes that there has been an increase in applications to transfer money offshore. This activity has led to concern over the difference between the treatment of capital gains under para 80 of the Eighth Schedule to the Act and s 25B. Under para 80 attribution of a capital gain is possible only to a resident beneficiary, while s 25B does not contain such a limitation for income. The result is that:
- non-residents may not be taxable on foreign source amounts;
- tax recovery actions may be difficult; and
- SARS may not have the information necessary to identify the ultimate beneficiaries when the beneficiary of the resident trust is a non-resident trust.
The common law conduit principle
In
C: SARS v The Thistle Trust[1] the appellant argued that despite para 80 of the Eighth Schedule permitting attribution only to residents, a capital gain could flow through multiple trusts under the common law conduit principle. The Supreme Court of Appeal rejected this argument despite it being entertained in the tax court.[2] That case was taken on appeal to the Constitutional Court and heard on 8 February 2024. At the time of writing, judgment was pending, but in my view, it would be surprising if the CC were to rule that the conduit principle had any role to play in s 25B or para 80. If the conduit principle allowed income or capital gains to flow to non-resident beneficiaries, the clear legislative intent as expressed in the newly amended s 25B and para 80 would be undermined.
Vesting trusts
At an online webinar on 29 February 2024,[3] SARS claimed that the amended s 25B also applied to vesting trusts. But whether that view is correct seems questionable, and it would be helpful if SARS were to issue an Interpretation Note on this subject to clarify its formal position.
Section 25B(1) begins by referring to 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'.
The definitions of 'trust' and 'trustee' in s 1(1) refer to assets being administered by a person acting in a fiduciary capacity, which would encompass both discretionary and vesting trusts.
However, in my view, whether vested rights are brought within s 25B(1) needs to be determined with reference to the words 'received by or accrued to'. In
Geldenhuys v CIR the court stated that 'received by' meant[4]
'received by the taxpayer on his own behalf for his own benefit'.
And in
Lategan v Cir the court stated that 'accrued' meant[5]
'to which he has become entitled'.
The next question is what is meant by 'in his or her capacity as the trustee of a trust'.
Could this mean not only amounts received by the trust as owner but also amounts to which the beneficiary has a vested right?
In my view, the words 'received by or accrued to' refer to amounts that belong to the trust. Those amounts are derived by the trustee in his or her capacity as such. Amounts held by the trust on behalf of a beneficiary accrue to the beneficiary. and are held by the trustee as a quasi-agent or administrator. Attempting to tax a trust on income which accrues to a beneficiary is tantamount to taxing a nominee or agent and there are a string of cases that reject that proposition.[6] In
CIR v Genn & Co (Pty) Ltd the court stated:[7]
'If, for instance, money is obtained and banked by someone as agent or trustee for another, the former has not received it as his income.'
In addition, s 25B(1) is subject to s 7. Section 7(1) provides as follows:
'7. When income is deemed to have accrued or to have been received.—(1) Income shall be deemed to have accrued to a person notwithstanding that such income has been invested, accumulated or otherwise capitalized by him or that such income has not been actually paid over to him but remains due and payable to him or has been credited in account or reinvested or accumulated or capitalized or otherwise dealt with in his name or on his behalf, and a complete statement of all such income shall be included by any person in the returns rendered by him under this Act.'
When a beneficiary has a vested right to income under the trust deed and chooses to allow it to be accumulated in the trust on his or her behalf, that income clearly accrues to the beneficiary under the core rules and s 7. Such a vested right is an accrued right.[8]
My above view is consistent with the way SARS treats vested assets of non-residents for capital gains tax purposes.[9] Once an asset has been vested[10] in a non-resident beneficiary and any capital gain is taxed in the trust or hands of a resident donor, any further disposal of the vested asset by the trustee is an action on behalf of the beneficiary, and it is the beneficiary that must account for any further capital gain or loss, assuming the asset falls within para 2(1)(b) of the Eighth Schedule such as immovable property in South Africa.
Discretionary trusts
The position with income accruing to a discretionary trust is, however, different. Despite such income having been received by or accrued to the trust, s 25B(1) overrides the principle that income cannot be disposed of after accrual[11] and deems it to accrue to a resident beneficiary. The result is that when the trustees vest income in a non-resident beneficiary, there is no longer any mechanism to remove it from the trust and deem it to accrue to such a beneficiary.
Rather inconsistently, s 7(5) can still result in such income being attributed to a non-resident donor, while para 70 of the Eighth Schedule does not permit a capital gain to be attributed to a non-resident donor.
The purpose of s 25B(2) seems to be to clarify that when a trustee exercises a discretion over income that has been received by or accrued to the trust in a year of assessment, it will be treated as having accrued to the beneficiary and retain its character as income despite being vested after receipt or accrual by the trust. Section 25B(2) also excludes non-resident beneficiaries from its ambit, so if income is vested after accrual in a non-resident beneficiary, it will remain taxable in the trust unless attributed to a donor under s 7.
The effect of the amendments to s 25B
The effect of the amendments to s 25B can have severe consequences. For example, under the previous wording of s 25B, income vested in a non-resident beneficiary would have been attributed to that beneficiary. The non-resident beneficiary was taxable on income vested in him or her from a South African source (for example, rental income from immovable property in South Africa) but interest income may well have been exempt from normal tax under s 10(1)(h). Income from a non-South African source was not taxable in the hands of the non-resident beneficiary. There was also a chance that the non-resident beneficiary would have enjoyed a lower rate of tax ranging from 0% to 45% because of the sliding scale applicable to natural persons.
In other situations, the vested amount, such as a local dividend, royalty income or interest on a private company loan account, may have attracted a lower rate of withholding tax by virtue of a tax treaty.
Now, all income, regardless of its source, vested in a non-resident beneficiary, is subject to normal tax in the trust at 45% unless it can be attributed to a donor under s 7.
Tax treaties
In its final response document on the various 2023 amending acts dated 2 February 2024, SARS and National Treasury addressed two issues concerning the amendments to s 25B and South Africa's tax treaties. The first comment was that the amendment may cause economic double taxation as the trust will pay tax in South Africa while the non-resident beneficiary may pay tax on the distributed amount in another country. Response: Article 1(2) of the 2017 OECD Model Treaty provides as follows:
'2. For the purposes of this Convention, income derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the tax law of either Contracting State shall be considered to be income of a resident of a Contracting State but only to the extent that the income is treated, for purposes of taxation by that State, as the income of a resident of that State.'
The words 'considered to be income of a resident of a Contracting State' do not grant the foreign country an exclusive taxing right (see article 1(3)) but merely enable it to grant double tax relief.
For example, if the beneficiary of a South African resident trust is resident in Country X, and Country X regards the trust as fiscally transparent, Country X should provide tax relief under the equivalent of article 23A (exemption method) or 23B (credit method) for the normal tax paid by the trust on the income vested in the beneficiary. The relief Country X has to provide is limited under article 23B(1) to the tax it imposes on the income.
In addition, article 3(1) of the multilateral instrument (MLI) ratified and deposited by South Africa in 2022, became effective in South Africa on 1 January 2023, and contains similar wording to article 1(2). The response , however, drew attention to the OECD commentary in para 5 which noted that
'States should not be expected to grant the benefits of a bilateral tax convention in cases where they cannot verify whether a person is truly entitled to these benefits'.
This qualification relates to the obtaining of adequate information from the entity concerned (that is, the resident South African trust).
The second comment was that the amendment resulted in a conflict with article 24(1) of the OECD Model Treaty relating to non-discrimination. Response: The proposed amendment does not provide different treatment based on nationality and therefore there is no discrimination.
Consequential amendments were made to s 49D and 50D (exemption from withholding tax on royalties and interest respectively) to exempt a distribution or a royalty or interest received by or accrued to a trust that is distributed to a beneficiary. Given that the amount was received by or accrued to the trust, I question whether these amendments were necessary as they would represent a distribution of after-tax trust capital.
Conclusion
The amendments to s 25B might result in more taxes for the fiscus in the short term. But our lawmakers should bear in mind that in raising taxes, for every action there is often an unequal and opposite reaction, which might result in less taxes being collected in the long run. The amendments to s 25B have made resident trusts an expensive vehicle for housing assets for the benefit of non-residents.
