Member Article

A significant change to the tax treatment of income which is vested by a South African trust in non-resident beneficiaries has been proposed in Annexure C of the 2023 Budget Review (the “Review”), which sets out additional tax amendments for the upcoming legislative cycle.

Under current South African statute and common law, a trust is regarded as a “conduit” or flow-through vehicle in relation to receipts and accruals of income by trustees where such amounts are vested in a beneficiary in the same year of assessment as the income is received by or accrues to the trustees. In this instance, the income is taxable in the hands of the beneficiary in whom the amount has been vested, regardless of whether the beneficiary is a resident or a non-resident for tax purposes.

This differs from the tax treatment of capital gains arising in respect of the disposal of capital assets by a trust and which are vested in a beneficiary in the same year of assessment. In the case of a capital gain which is vested in a beneficiary, the attribution of the capital gain to the beneficiary only applies if the beneficiary is a South African tax resident. Where the beneficiary is a non-resident, the capital gain is subject to capital gains tax in the hands of the trust and not in the hands of the beneficiary.

The proposed amendment will change the taxation of income distributions by a South African trust to align this with the taxation of capital gains vested in a beneficiary. In other words, income which is vested in a South African resident beneficiary in the same year of assessment will continue to be taxable in the beneficiary’s hands on the current flow-through basis. However, any income which is vested in a non-resident beneficiary will be taxable in the trust at an income tax rate of 45%.

Presumably, where income is vested in a non-resident beneficiary and taxed in a trust, there should be no South African tax implications for the non-resident beneficiary.

The reason given for this change is the gradual relaxation of exchange control regulations which, according to the Review, has led to an increase in applications to SARS for confirmation of the tax compliance status of individuals for purposes of transferring funds offshore. The Review states that government is concerned about the difference between the rules governing the tax treatment of income and capital gains distributed to beneficiaries, in terms of which capital gains can only be attributed to beneficiaries who are South African tax residents and cannot flow through to non-resident beneficiaries.

The Review also states that the flow-through of amounts from South African tax resident trusts to non-resident beneficiaries makes it difficult for SARS to collect income tax from those non-resident beneficiaries as it is more complicated to enforce recovery actions against non-residents.

When this change is introduced, the potential impact on the tax liability of South African trusts will have to be considered. It will also be important to consider the interplay of the amended tax provision with the donor attribution rules (SARS’ views on which are set out in Interpretation Note 114), as well as the withholding tax regime for interest and dividends.

The exchange control implications of distributions by a South African trust to a non-resident beneficiary should also be considered. In this regard, where the non-resident beneficiary is a foreign trust, SARS has confirmed that they would consider approval for the transfer of funds vested in the non-resident trust, provided that a manual letter of compliance is obtained from SARS.