Exchange control relaxations that permit trust‑to‑trust distributions have been widely welcomed, with hundreds of millions of rands flowing into offshore trusts.
Yet significant uncertainty remains about the income tax and capital gains tax (CGT) treatment of these distributions and the approach taken by the South African Revenue Service. The central concern is whether such cross‑border movements of capital could trigger the anti‑avoidance attribution rules in the Income Tax Act.
Before the change, direct distributions between a South African trust and a foreign trust were prohibited. Now they require only a letter of compliance from SARS, and the South African Reserve Bank can allow the money to flow. The approval is subject to certain requirements.
Stephan Spamer, director in Cliffe Dekker Hofmeyr’s tax and exchange control practice, says what remains unclear is whether a trust-to-trust distribution constitutes a “donation, settlement, or other disposition” in terms of section 7(8) of the Act.
This provision is part of a series of anti-avoidance measures to combat schemes where taxpayers attempt to minimise tax liability by diverting income-producing property away from themselves.
The section stipulates that if any donation, settlement, or other disposition by a resident results in income accruing to a non-resident, that income must be attributed back to the resident donor.
Nicole Paulsen, tax director at Osborn Wellsted Paulsen, says the new exchange control framework has been in place for the past three years. The requirements for approval include that the offshore trust must be a named beneficiary of the local trust, the local trust must be tax compliant in all respects, and the trustees of the local trust must apply to SARS for a manual letter of compliance. The letter must be accompanied by a copy of the trust deed and resolutions by the trustees, as well as details of the source of funds being distributed.
The concern – probably because of the increased uptake of the framework – is that SARS may start applying the attribution rules to trust-to-trust distributions. However, it seems as if the market is saying that will be “non-sensical”.
Gratuitous intent
Spamer is of the view that it would be “fundamentally wrong” if the attribution rules are applicable to trust-to-trust distributions. The main reason is that trustees do not have a “gratuitous intent” when they make distributions. To say that the trustees made the settlement or other disposition gratuitously would be a step too far.
The words “donations, settlements, and other dispositions” are linked to a gratuitous intent that will trigger the attribution rules.
“The question is whether the action of a trustee to make a distribution to a foreign beneficiary trust is of a gratuitous nature. It cannot be. The trustee is not dealing with his own money or assets. He acts from a fiduciary obligation in terms of the trust deed.”
If trust-to-trust distributions are all captured under the banner of donation, settlement, or other disposition, it will open a “floodgate of problems”, says Spamer.
This will effectively mean that every distribution from a local trust to a non-resident beneficiary will trigger the attribution rules under section 7(8). This will place an “unworkable compliance burden” on local trustees.
He provides the example of a local trust making a distribution to a foreign trust and the money is used to buy a rental property in the United Kingdom. If the attribution rules are applied, it means the rental income will be attributed perpetually back to the local trust.
Even with the rebate mechanism for foreign taxes paid, it will create an “administrative nightmare”. The local trustees will effectively have to administer the foreign trust, forcing them to become “shadow accountants” for a foreign trust.
Paulsen is also of the view that a trust-to-trust distribution from a local trust can in “no way” be a donation to the foreign trust or to any beneficiary in the foreign trust.
“It, in fact, constitutes a distribution, and in accordance with statutory interpretation, a distribution by a trust to a beneficiary cannot constitute a donation, as this could potentially result in double taxation.”
Paulsen says that leaves the question whether it can still be a “settlement or other disposition” because the attribution rules are triggered if there is a “donation, settlement, or other disposition”.
“Our view as a firm is – and it is subject to final confirmation from senior counsel – that the section is not triggered.”
She says – playing devil’s advocate – if the attribution rules are triggered, the foreign trust may “ring-fence” the amount distributed and use it only as a currency hedge.
Another option would be to “kill the grandfather”. Paulsen gives the example where a local trust only holds shares in a company that is “pregnant with dividends”. Once the dividends are declared and the tax is paid, the trust is dissolved.
Paulsen notes that the initial enthusiasm has been dampened because of the lack of liquidity to make a distribution. SARS is dangling a carrot to entice the local trust to declare dividends (and pay 20% dividends withholding tax) or dispose of an asset (and pay CGT).
Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law, and regulatory issues.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article is a general guide and should not be used as a substitute for professional tax advice.
