Article by: Regan van Rooy
It is no secret that the South African
Revenue Service (SARS) is suspicious of trusts, especially
international ones. They are generally considered by SARS to be enabling
mechanisms for tax avoidance. That is why so many measures have been
introduced in recent years to discourage their existence. Not only are
they subject in South Africa to the highest tax rates (i.e. 45% normal
income tax and 36% capital gains tax), they are also the target of
stringent anti-avoidance provisions in South African income tax
legislation. (See, for example, recent laws discouraging South Africans
holding foreign companies through foreign trusts discussed in our
newsletter dated 6 May 2020). A newly issued draft interpretation note
from SARS controversially attempts to put yet another stumbling block in
the way of those South Africans who may use offshore trusts to hold and
distribute their foreign assets and revenue.
The interpretation note, released on 22 June 2020, concerns primarily section 7(8)(a) of the South African Income Tax Act. Section 7(8) forms part of an array of rules in the Act which seek to attribute the income and capital gains of trusts to their SA resident “donors”, the taxpayers who founded the trust, under specific circumstances. The idea behind these provisions is broadly to hit these donors with the taxes that they otherwise would have had if they had not transferred their assets to a trust by way of a donation, interest-free loan or other so-called “gratuitous disposition”.
Section 7(8)(a) works specifically to impute amounts to a SA resident donor where:
- the amount is received by or accrues to a non-resident, e.g. an offshore trust or its non- resident beneficiary, by reason of that donor’s gratuitous disposition; and
- such amounts would have been treated as income for South African tax purposes had that offshore party been South African resident.
Traditionally this provision has blocked SA taxpayers from escaping the SA tax net by secreting their assets to offshore trusts. In the past, the only ways around this provision were:
- to sell assets to the trust at market value in return for cash; or
- to loan the trust funds at an arm’s length interest rate so that it could buy the assets; or
- to have the trust distribute its income each year to a SA resident beneficiary who is not the donor and in whose hands it would ordinarily be taxed.
It is the last- mentioned method that
the Interpretation Note attacks. According to SARS, even if the trust
distributes its income to a SA resident, such income would still have
been received or accrued by the offshore trust. Hence all of such
income, including the distribution to the SA resident, falls to be
imputed to the donor under that provision.
SARS’s interpretation is highly debatable. It is contrary to how the provision has been interpreted for the 20 years of its existence. Furthermore, it is impractical as it would require beneficiaries that receive or accrue income from an offshore trust to disclose the income, but also having to explain to SARS why they should not be taxed on such amounts, which would be administratively difficult to say the least.
It is quite possible, given this criticism, that SARS will withdraw the Note. However the fact that SARS saw fit to issue it in its current form, should give SA donors and tax planners pause. It means that SARS, in their desperate attempt to fill state coffers, depleted by the COVID-19 pandemic, has trusts, especially foreign trusts, firmly in their cross-hairs.