Tax Treatment of Awards Received from Foreign Trusts by South African Beneficiaries

Where a South African tax resident beneficiary receives an award from a foreign trust, it is important that they ascertain the nature of the distribution received from that trust, so that they may correctly disclose the nature of the amount received from the trust for tax purposes in South Africa.

The tax payable by the beneficiary on an award received from a foreign trust will depend upon the precise nature of the distribution received from the foreign trust.

It must be remembered that under section 102 of the Tax Administration Act, No. 28 of 2011 (“TAA”) the taxpayer must discharge the onus of proof as to whether an amount is exempt from tax or is taxable. 

Thus, where a taxpayer is unable to determine the underlying nature of the amount received from a foreign trust, SARS would be fully entitled to regard that amount as normal income fully liable to tax in South Africa.

It would be far preferable if the foreign trustees assisted the South African beneficiary by advising them as to the nature of the amounts comprising the distribution made to the beneficiary so that the tax exposure relating to that distribution can be properly managed.

Where the beneficiary receives a return of trust capital, that clearly will not be taxable on the basis that it is a return of capital which falls outside of the rules taxing capital gains in South Africa imposed under the Eighth Schedule to the Income Tax Act, No. 58 of 1962, as amended (“the Act”).

Where, however, a foreign trust disposes of assets and realises capital gains thereon and subsequently makes an award to a South African beneficiary, the beneficiary will then receive a capital gain and depending on the circumstances that may or may not be taxable in South Africa.

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Paragraph 80(3) of the Eighth Schedule to the Act deals with the position where a resident acquires a vested right to any amount representing the capital of any foreign trust and that capital arose from a capital gain of that trust or any amount which would have constituted a capital gain of that trust if that trust had been tax resident and determined in any previous year of assessment during which the resident beneficiary had a contingent right to that capital and that capital gain was not subject to tax under the provisions of the Act. 

In such circumstances the amount received must be taken into account for purposes of calculating the aggregate capital gain or aggregate capital loss of the resident beneficiary in that year of assessment.

Thus, where a foreign trust disposes of assets and realises a capital gain thereon in say the 2014 tax year and subsequently awards that gain to the resident beneficiary in the 2015 tax year, that gain will then be taxable as a capital gain in South Africa. 

However, where the trust disposes of assets and realises a capital gain and distributes that to a resident beneficiary in the same year of assessment, it is apparent that the capital gain will not be taxable in the hands of the resident beneficiary. 

This interpretation is supported by the comments made in the Davis Tax Committee’s Interim Report on Estate Duty, where at page 45 the following is stated:

“However, unlike paragraph 80(3) this provision suffers from deficiency, in that it refers to a capital gain and not to an amount that would have constituted a capital gain had the non-resident trust been a resident. It can thus only apply to the limited range of assets referred to in paragraph 2(1)(b). Consequently, SARS is powerless to subject most gains of a non-resident trust to CGT in the hands of resident beneficiaries when such gains are distributed in the same year of assessment in which they arise.”

Thus, where a foreign trust realises a capital gain, it is in the interests of the South African resident beneficiary that that capital gain is distributed in the same tax year, thereby ensuring that the amount escapes tax in the hands of the beneficiary based on current statutory provisions.

Where, the foreign trust derives income in the form of interest, dividends etc. it is important to know what part of the distribution relates to the different categories of income. 

This flows from the provisions of section 25B(2A) of the Act which regulates the tax consequences flowing from distributions received by a resident beneficiary from a foreign trust. 

In principle, where the foreign trust derives income and awards that to a resident beneficiary in the same tax year or in a subsequent tax year, the resident beneficiary will need to ascertain the composition of the distribution received so that they can analyse the award into its constituent parts. 

Where, for example, the foreign trust receives interest income that will retain its nature and will be taxed as interest in the hands of the beneficiary in South Africa upon receipt, regardless of the fact when that was received, unless it was derived prior to 2001 being the year in which South Africa moved to the worldwide basis of taxation. 

Insofar as dividends are concerned, where the foreign trust derives dividends and awards that to a beneficiary the income tax payable thereon will generally not exceed 15% based on the provisions of section 10B of the Act. It would be necessary to consider the particular facts and circumstances of the trust in question.

Where a South African resident beneficiary receives a distribution from a foreign trust and they are unable to identify the constituent parts of that distribution, the full amount would be treated as taxable by SARS.

Those persons who applied for amnesty under the 2003 amnesty legislation were required to accept that the assets owned by the foreign trust were regarded as theirs for income tax and capital gains tax purposes and as and when income is derived by the foreign trust, that will be taxed in the hands of the amnesty applicant.

The Davis Tax Committee has recommended that in future all distributions of foreign trusts be taxed as normal income. This proposal is justified by the Committee on the basis of seeking to discourage the creation of offshore trusts because of the deferral of the tax that a beneficiary obtains through the use of an offshore trust. 

However, this proposal does not take account of the fact that many persons applied for amnesty and are paying tax on income generated by foreign trusts as and when derived and should those trusts make distributions, it would be inequitable if those distributions are taxed again as a  result of the proposal contained in the Davis Tax Committee Report. This would constitute double taxation which cannot be justified and it is hoped that this proposal to summarily regard all amounts received from foreign trusts as income will not be accepted.

In conclusion therefore it is contended that trustees of foreign trusts should assist South African tax resident beneficiaries of those trusts by recording the distributions made to the resident beneficiary and the precise nature thereof so that the beneficiary can correctly disclose those amounts for tax purposes.

A further point to consider is that where distributions are received from a foreign trust, that should be disclosed to the exchange control authorities through the normal banking channels, particularly where the distribution is received in South Africa. 

Should the beneficiary wish to retain the distribution offshore, they should seek permission from their authorised dealer to do so for exchange control purposes.

Dr Beric Croome is a Tax Executive  at ENSafrica This article first appeared in Business Day, Business Law and Tax Review, September 2015. 

The Taxing Affair of Tax Avoidance on Trusts

In the National Budget speech, presented to Parliament on 27 February 2013, the Minister of Finance indicated that legislative measures will be introduced to address tax avoidance arising from the utilisation of trusts.  

The National Treasury has since indicated that a discussion paper will be released dealing with the taxation of trusts generally prior to amending legislation being introduced.  Initially, there were concerns that the taxation of trusts would be amended in the 2013 Draft Taxation Laws Amendment Bill, but, fortunately, no amendments are contained in the legislation which was released for public comment on 4 July 2013.

South African residents who are beneficiaries of foreign trusts
must record and report all distributions

It is appropriate, therefore, to revisit the tax consequences facing South African residents who are beneficiaries of foreign trusts.

A significant number of South Africans applied for and received amnesty under the Exchange Control Amnesty and Amendment of Taxation Laws Act, No 12 of 2003, whereby prior violations of exchange control regulations and tax laws of South Africa were regularised.  

As a consequence of having applied for and having received amnesty, the South African resident who applied for tax amnesty regarding funds remitted from South Africa to a foreign trust had to make an election under section 4 of the amnesty legislation that any amount of income derived by the foreign trust would remain attributable to that resident so long as they are alive.

Thus, as and when the foreign trust derives income from the investments held by it in the form of interest, rental or foreign dividends, those amounts of income must be disclosed and declared to tax in South Africa by the person who applied for and received amnesty in terms of the 2003 amnesty legislation.  Likewise, should the foreign trust dispose of assets and realise capital gains thereon, the South African resident is required to declare those capital gains for tax purposes in South Africa.

When the person who funded the trust ultimately passes away, they are deemed to have disposed of the assets held by the foreign trust at market value on the date before their date of death and are liable to capital gains tax on the increase in value of the assets owned by the trust compared to the cost thereof. 

Should a trust for which amnesty was received subsequently make distributions to a South African resident after the funder of the trust has passed away, it is important to ascertain what amounts were previously liable to tax in South Africa, as those will not be liable to tax in the hands of the beneficiaries upon receipt as they would have been taxed previously.  

Clearly, income derived by the foreign trust after the date of death of the funder will, on distribution to a South African resident, fall to be taxed in their hands, in terms of section 25B(2A) of the Income Tax Act, No 58 of 1962, as amended.

With effect from 1 November 2010 until 31 October 2011, those taxpayers who had chosen not to apply for the amnesty under the amnesty legislation were entitled to seek relief from both the tax and exchange control authorities in terms of the Voluntary Disclosure Programme and Taxation Laws Second Amendment Act, No 8 of 2010. 

Where a South African resident has donated funds to a foreign trust and the trust derives income as a result of such donation, the income attributable to such donation will fall to be taxed in the hands of the South African resident under section 7(8) of the Act.  

Once again, once the funder of the foreign trust passes away, the deeming rule will cease to operate and it will be necessary to ascertain the nature of distributions made by the foreign trust to the South African resident beneficiaries to determine the manner in which such distributions should be dealt with from a tax point of view.

It must be remembered that the burden of proof, which was previously contained in section 82 of the Act and which is now contained in section 102 of the Tax Administration Act, No 28 of 2011, falls on the taxpayer to prove whether an amount received is exempt or otherwise not taxable.  

Thus, where a South African resident receives a distribution or an award from a foreign trust, it will be necessary for the beneficiary to satisfy the Commissioner: South African Revenue Service as to the underlying nature of the award received by them.  Where the amount received represents the accumulation of income derived by the foreign trust over many years, such amount will fall to be taxed as normal income in the hands of the South African resident in terms of section 25B(2A) of the Act.  

This is particularly the case where a foreign trust was created by a non-resident and subsequently that trust makes awards to South African tax resident beneficiaries.  

Where, however, the trust was funded by a South African resident and amnesty applied therefore or, alternatively, relief under the voluntary disclosure programme, it becomes necessary to determine whether the amounts were previously taxed in the hands of a resident beneficiary or not.

Where the distribution received by a South African tax resident beneficiary can be shown to originate out of capital gains realised by the foreign trust, those gains will fall to be taxed in the normal way insofar as capital gains are concerned, with the maximum tax rate of 13.33% applicable.

When the funds are transferred from the foreign trust to the South African resident beneficiary, such funds will enter the country via normal banking channels, and the South African recipient will be required to inform their bank as to the nature of the proceeds for exchange control purposes.  The bank receiving the funds is required to report the funds received to the South African Reserve Bank under the applicable Balance of Payment (“BOP’) code, which is a four digit code specifying the precise nature of the funds received from abroad for reporting purposes.

With effect from 1 April 2012, South Africa changed the manner in which both domestic and foreign dividends are taxed.  When a South African company pays a dividend to a shareholder, the company is required, ignoring exemptions and double taxation agreements, to withhold tax at the rate of 15%, such that the South African individual shareholder will receive 85% of the cash dividend declared to shareholders.

Section 10B of the Act was introduced to ensure that domestic and foreign dividends are taxed uniformly, with the result that a South African resident receiving foreign dividends will be liable to tax thereon at the maximum rate of 15%.  Thus, to the extent that a South African resident receives foreign dividends from a foreign trust, those dividends will be liable to tax at a maximum of 15%.

Where South African residents have illicitly removed funds from South Africa and created foreign trusts utilising such funds, they can utilise the Voluntary Disclosure Programme contained in the Tax Administration Act to regularise their income tax defaults with the Commissioner: SARS.  Unfortunately there is no current voluntary disclosure programme applicable insofar as the exchange control authorities are concerned.  

However, persons wishing to regularise foreign assets held in contravention of the exchange control regulations should approach an authorised dealer or, alternatively, the Financial Surveillance Department of the South African Reserve Bank with a view to regularising the funds held abroad without the consent of the authorities. 

The current voluntary disclosure programme contained in the Tax Administration Act is not as beneficial as that which was available in 2010/2011, in that the interest not paid on the tax due to the Commissioner remains payable.  

Generally, in the understatement penalty which would otherwise have been imposed should be waived, and, furthermore, any applicant will not be subject to criminal prosecution, which would be the case if the Commissioner were to identify the person prior to them approaching SARS for relief under the voluntary disclosure programme.  

Where funds have been removed from South Africa in contravention of the exchange control regulations, a levy will remain payable to the South African Reserve Bank to regularise the assets held offshore.

It is important, though, that South African residents who receive distributions from a foreign trust are able to ascertain the nature thereof so as to properly record and report the distribution in their personal income tax returns and account for the correct amount of tax thereon.  

If the trustees of the foreign trust are unable to assist the South African resident beneficiary as to the true composition of the distribution made to the South African resident beneficiary, it will be extremely difficult for the South African tax resident to satisfy the Commissioner that the amount received should not be subject to normal tax.  

It would far preferable if the foreign trustees are in a position to indicate the underlying nature of the amount awarded to the South African beneficiary indicating what part of the distribution relates to interest, rentals, foreign dividends, capital gains or, alternatively, awards of capital originally received by the trust.  

It remains to be seen how the tax authorities will ultimately change the rules applicable to taxing trusts in South Africa.

Dr Beric Croome is a Tax Executive at Edward Nathan Sonnenbergs Inc. This article first appeared in Business Day, Business Law & Tax Review (September 2013). Image purchased from iStock