A good friend and colleague, Mervin Messias
, a doyen of estate planning, explains the principles.
The general principles are as follows:
1. Tax residency (and thus the right of a jurisdiction to impose tax) is usually dependant on either the place of establishment/formation, or the place of effective management (see the OECD Model Tax Treaty and Meyerowitz on Income Tax paragraph 5.19).
2. In the case of a trust, the tax jurisdiction is the place of effective management which is where the Trustees meet to deal with the affairs of the trust. (See SARS Interpretation Note 6)
3. A trust which has RSA trustees and management here would thus need to register as a taxpayer, as RSA persons and entities are subject to tax on a worldwide basis (see definition of ‘resident’ and ‘gross income’ in section 1 of the Income Tax Act 58 of 1962 as amended)
4. Tax payable
4.1 Subject to the normal rules on taxable income, a trust pays income tax at a flat rate of 40% on income and an effective 20% (40% x 50%) on capital gains.
4.2 If the income or capital gain is vested (usually by resolution) in a beneficiary in the same tax year as receipt or accrual, the beneficiary is assessed to tax and not the trust. This may be beneficial as a natural person beneficiary rate is 18 – 40% (income tax) and an effective 4,5% to 10%, (CGT).
4.3 A mere return of original injected trust capital (whether in cash or in specie) is not a tax event.
4.4 RSA estate duty is not levied on trust property irrespective of where the trust was established and/or managed.
5. Income distributed by a foreign trust
5.1 In terms of S25B (of the Income Tax Act) income which vests in beneficiaries is deemed to accrue to them.
5.2 If the beneficiary of a non-resident trust is a South African resident all the income which vests is subject to tax in South Africa in that resident’s hands. In terms of the conduit pipe principle, the income retains its nature.
6. Capital distributed by a foreign trust
6.1 S25B(2A) deals with distribution of capital made by non-resident trusts. The section provides that where during the year of assessment any resident acquires a vested right to any amount representing capital of any trust which is not a resident, that amount must be included in the income of the resident; if –
6.1.1 that capital arose from any receipts or accruals of the trust which would have constituted income if such trust had been a resident, in any previous year in which the resident had a contingent right to that amount; and
6.1.2 that amount has not been subject to tax in the Republic
6.2 There is no tax effect if the foreign trust distributes original capital to a South African beneficiary, or capital that has already been taxed in South Africa.
7. The conduit pipe principle and the offshore trust
7.1 S25B(2A) has countered a fairly obvious form of avoidance. Assume that income of R100 is earned by the offshore trust in year 1 and that no distribution is made to the discretionary beneficiaries. The R100 has not been subjected to tax in South Africa. The R100 is accordingly capitalized. In year 2, the trustees vest R100 in beneficiary A, a South African resident. In terms of S25(2A), the resident will be taxed on the R100 in year 2, i.e. the year of vesting. In this way the section counters the ability of trustees to employ the conduit pipe principle in a manner designed to avoid tax on the R100.