Tax avoidance – The taxing affair of tax avoidance on trusts

by Beric Croome, September 09 2013, 16:32

IN HIS budget speech this year, Finance Minister Pravin Gordhan indicated 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 July 4.

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 of their 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 on receipt as they would have been taxed previously. 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 November 1 2010 until October 31 2011, those taxpayers who had chosen not to apply for the amnesty under the amnesty legislation were entitled to seek relief from 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.

The burden of proof falls on the taxpayer to prove whether an amount received is exempt or otherwise not taxable.

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 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 code, which is a four digit code specifying the precise nature of the funds received from abroad for reporting purposes.

With effect from April 1 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 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 the financial surveillance department of the Reserve Bank to regularise the funds held abroad without the consent of the authorities.

The voluntary disclosure programme contained in the Tax Administration Act is not as beneficial as that which was available in 2010-11, in that the interest not paid on the tax due to the Commissioner remains payable. Generally, 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 Reserve Bank to regularise the assets held offshore.

It is important 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.

Dr Beric Croome is a tax executive at ENS.