Trust Beneficiaries Beware
The Current Legalities
When income is generated within a South African trust and distributed to a beneficiary within the same fiscal year, it does not get taxed at the trust level. Instead, the beneficiary bears the tax liability, regardless of whether they reside in South Africa or live abroad. This contrasts SARS’s perspective on the taxation of capital gains earned by a South African trust.
Annexure C of the 2023 Budget Review states that a capital gain allocated to a trust beneficiary will only be taxable for that beneficiary if they are a South African tax resident. When the trust beneficiary is not a tax resident of South Africa, the capital gain is “trapped”, and SARS intends to levy tax on this gain at trust level.
This proposed process has been challenged, and the definitive stance on this issue remains undetermined. However, should this change be implemented, capital gains allocated to overseas beneficiaries would be taxed at a rate of 36%. This contrasts capital gains tax, where the maximum rate applied is 18%.
Understanding The Proposed Changes
These proposed changes have caused concern for National Treasury about the unequal tax treatment of income versus capital gains distributed to beneficiaries. In Annexure C of the Budget Review, the National Treasury has indicated that the transfer of amounts from trusts with South African tax residency to beneficiaries not residing in the country complicates the task for SARS in collecting income tax, noting that enforcing recovery actions against non-residents presents evident difficulty.
As a result, it has been suggested that the regulations related to this income should be harmonised with those applicable to capital gains. This indicates that any income allocated to a beneficiary who is a South African tax resident within the same tax year will remain taxable in the hands of the beneficiary. However, any income allocated to a foreign beneficiary will remain “trapped” and taxed at the level of the South African trust. The modification proposes that any income accrued by or received by a South African trust and allocated to a foreign beneficiary within the same tax year will be taxed at a flat rate of 45%.
The potential consequences of this proposition could significantly affect South African tax resident trusts and their foreign beneficiaries. The detailed effects will need further examination before the final legislation is introduced in upcoming legislative cycles. Though, taking into account the reasoning provided by the National Treasury, it is believed that the intended amendment is rather severe – ringing true as the foreign beneficiary could be liable to pay tax in their country of residence as well, without the benefit of a foreign tax credit for those paid to the South African trust.
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