THE TYPICAL SCENARIO
In order to preserve the family’s wealth for future generations, a family trust was created by the father, who at the time did not foresee his children going overseas. The trust was therefore a South African trust, with the family members as beneficiaries. Given that the world has become a global village and living and working abroad has become the norm, it is not unexpected that the son, for instance, decides to spread his wings and relocate to London.
It is, unfortunately, commonplace that living abroad can be expensive, especially during the initial years. Financial assistance from the family trust can prove invaluable in these times and in later years. For this reason, the trustees may decide to distribute some of the trust funds to the son. However, before reliance can be placed on such financial assistance, it is essential that the trustees and the relevant beneficiary consider whether the trust distributions can flow to the son in the first place and, secondly, what the tax consequences of these distributions are.
This article will analyse the local tax implications of such trust distributions, with an analysis of the offshore tax considerations to follow in the next issue.
LOCAL TAX CONSIDERATIONS
As is mostly the case where tax considerations are concerned, there is no clearcut answer. This is especially true for trust distributions made to beneficiaries living abroad. The tax legislation involved is extremely complex and clarity over the tax residency of the beneficiary living abroad is needed to determine which tax legislation specifically applies. Disagreement over the tax residency of the beneficiary living abroad is often the root of tax disputes with the South African Revenue Service (SARS). It is therefore essential that proper consideration is given to the tax residency of the beneficiary liv- ing abroad in order to determine on which basis the tax return should be submitted to SARS.
TAX RESIDENT IN SOUTH AFRICA OR NOT?
A natural person can be a tax resident in South Africa in one of two ways: firstly, by being viewed as ‘ordinarily resident’ in South Africa or, alternatively, by being ‘physically present’ in the country for a specified amount of time. As this article deals with beneficiaries living abroad, the physical presence bears no relevance and is ignored for the purposes of this article; only the ordinary residence test will receive further consideration.
What does it mean to be ordinarily resident in South Africa? Is a physical presence in the country required? By no means – one can be ordinarily resident in South Africa without having spent a single day in the country during a particular tax year. The term ordinarily resident is not defined by the Income Tax Act and as such one has to look at case law for guidance. Our courts have, in essence, determined that one is ordinarily resident in the country where one normally resides, apart from temporary or occasional absences. In other words, the country to which one would naturally and as a matter of course return from overseas travel. SARS looks at several factors when making this determination, such as nationality, location of assets, family and social relations, to name a few. From the above, however, it is evident that it is not a straightforward question and professional advice is highly recommended.
Beneficiaries should take note if they are of the opinion that they are not tax resident in South Africa anymore, as it suggests that they have emigrated for tax purposes. This means that they should have paid a deemed capital gains tax charge on their assets to SARS on the day immediately preceding the date on which they supposedly ‘left’ South Africa. If such a charge was not paid to SARS, one should take the view that one is still tax resident in South Africa.
Below we outline the tax implications of trust distributions to beneficiaries living abroad, and distinguish between their status as a tax resident in South Africa or not.
BENEFICIARY LIVING ABROAD IS A TAX RESIDENT IN SA
In terms of the general principles, trust income and capital gains distributed to beneficiaries who are tax residents in South Africa will be taxable in South Africa in the hands of the beneficiary. Exceptions to the general rule can occur, however, when the so-called attribution rules apply. These rules are extremely complex to understand and apply, but in essence they have the effect that the amount (or part thereof) distributed to the beneficiary is taxed in the hands of the father (i.e. the funder of the trust) rather than in the hands of the beneficiary. However, in the typical scenario outlined above the attribution rules will in most cases not apply and the distribution amount should be taxable in South Africa in the hands of the son.
BENEFICIARY LIVING ABROAD IS NOT A TAX RESIDENT IN SA
Here is where it becomes really tricky.
Firstly, the conduit principle, which allows for income and capital gains to retain their nature and flow through the trust to be taxed in the hands of the beneficiaries, is not recognised as far as capital gains distributed to non-residents are concerned. The capital gains can therefore not flow through the trust to the non-resident beneficiary as is the case with a resident beneficiary. Therefore, in the event that a capital gain is distributed to the non-resident beneficiary, it will either be taxed in the hands of the father or the trust, depending on how the trust was funded. This is an important dittinction as the effective tax rate for capital gains in the trust is 27.31% as compared to 13.65% in the hands of individuals (who already fall within the maximum marginal rate of 41%).
Secondly, the attribution rules referred to above will in most cases be triggered where a non-resident beneficiary is involved. As mentioned above, this will have the effect that the income (or part thereof) which is distributed to the non-resident beneficiary is taxed in the hands of the father who funded the trust.
Experience has shown that the tax treatment of trust distributions to beneficiaries living abroad can be a tricky affair. Beneficiaries who relocate abroad and who would like to continue to benefit from distributions made to them by their family trust in South Africa should carefully consider the applicable exchange control and tax legislation involved. Seeking specialist advice in this regard is highly recommended. Unexpected surprises may prove costly, especially as the country in which the beneficiary is currently living will, in most instances, also seek to tax the trust distribution received.
SANLAM PRIVATE WEALTH (PTY) LTD, registration number 2000/023234/07 is a member of the Johannesburg Stock Exchange, a licensed Financial Services Provider, number 37473 and a Registered Credit Provider, NCRCP1867.
This article is for information purposes and should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed above are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness by Sanlam Private Wealth. Any expressions of opinion are subject to change without notice. Reproduction of this commentary is not allowed in whole or in part without prior written agreement from ‘Sanlam Private Wealth’.