Is dividends tax payable on the distribution of dividends to employees through a discretionary trust?

transfer pricing 101Authors: Gigi Nyanin and Nicole Paulsen

The South African Revenue Service (SARS) released Binding Private Ruling 209 (BPR 209), on 21 October 2015, which deals with whether dividends tax must be withheld from dividends distributed in cash by a company to a discretionary trust that in turn distributes such dividends to the beneficiaries of the trust. The beneficiaries of the trust are either employees of the company or its subsidiaries.

By way of background, s1 of the Income Tax Act, No 58 of 1962 (Act) defines a trust as any trust fund consisting of cash or other assets which are administered and controlled by a person acting in a fiduciary capacity, where such person is appointed under a deed of trust or by agreement or under the will of a deceased person. Where such person acting in a fiduciary capacity exercises their discretion to vest the trust assets (income or capital) in the beneficiaries, the trust is referred to as a discretionary trust.

In BPR 209, a Black Economic Empowerment (BEE) trust, hereinafter referred to as the Co-Applicant, was established by a private company incorporated in and resident of South Africa referred to as the Applicant. The Co-Applicant was established for the pursuance of BEE initiatives, through the provision of financial and other assistance to the beneficiaries of the Co-Applicant.

In terms of the trust instrument, the trustees may not make any distribution to a beneficiary who is an employee, unless the purpose of such distribution is to either incentivise the employee or to retain his or her services within the Applicant or its subsidiaries, pursuant to the BEE initiative. Furthermore, the trustees were prohibited from making a distribution which replaced the normal compensation and benefits that such beneficiaries would otherwise have received in their capacity as employees within the Applicant or its subsidiaries.

In terms of the proposed transaction, the Applicant intends to distribute dividends in cash to the Co-Applicant and the Co-Applicant in turn, will distribute such dividends to its beneficiaries.

Section 10(1)(k)(i)(ii) of the Act provides, among others, that dividends received by, or accrued to any person (including a trust) shall be exempt from normal tax unless such dividend is received by, or accrues to a person in respect of services rendered, or to be rendered, or in respect of, or by virtue of employment, or the holding of office.

Section 64F(1)(l) of the Act in turn provides that there shall be exempt from dividends tax any dividend paid to any person to the extent that the dividend constitutes income of that person, provided that the dividend does not consist of a dividend in specie.

SARS made the following ruling with regards to the proposed transaction:

  • the ruling only applies to dividends to be distributed to the following qualifying beneficiaries:
  • black employees of the Applicant or its subsidiaries; and
  • the trustees of the Co-Applicant who are also black employees of the Applicant or its subsidiaries;
  • the dividends to be received by the qualifying beneficiaries will not be exempt from normal tax as s10(1)(k)(i)(ii) of the Act will apply;
  • the dividends to be distributed to the qualifying beneficiaries will be exempt from dividends tax under s64(F)(1)(l) of the Act;

Therefore, the Applicant will not be required to withhold dividends tax from the dividends to be paid to the qualifying beneficiaries, provided that the necessary declarations and written undertakings as contemplated in s64G(2)(a) of the Act, have been provided timeously to the Applicant.