Changes to the Tax Treatment of Non-resident Beneficiaries of Trusts
Changes to the Tax Treatment of Non-resident Beneficiaries of Trusts
By Thato Mgoboli, Junior Tax Consultant and Martin Groenewald, Tax Consultant
Introduction
The recently released Draft Taxation Laws Amendment Bill of 2023 contains measures designed to address differences in the tax treatments of amounts of an income nature that are vested in non-resident beneficiaries of trusts in terms of section 25B of the Income Tax Act (‘the Act’) and capital gains that are vested in such beneficiaries in terms of paragraph 80 of the Eighth Schedule to the Act.
Background
Paragraph 80 of the Eighth Schedule deals with capital gains attributable to beneficiaries of trusts. When an asset is vested by a trust in a South African resident beneficiary, a capital gain flowing from the vesting is generally attributed to the resident beneficiary. The capital gain is then disregarded in the hands of the trust for purposes of calculating the taxable income of the trust. However, if an asset or gain is vested in a non-resident beneficiary, the capital gain flowing from the vesting is generally not attributed to the non-resident beneficiary but is taxed in the hands of the trust. Consequently, the effective tax rate is higher – a flat rate of 36%, whereas, if the capital gain had been taxed in the hands of the non-resident beneficiary who is a natural person, the effective tax rate would have been capped at a maximum of 18%.
Since paragraph 80 expressly only deals with capital gains, amounts of an income nature that flow through trusts are dealt with in terms of section 25B. Under the section as it currently reads, such amounts that are vested in a beneficiary during a tax year are generally deemed to accrue to a beneficiary and may be subject to tax in the beneficiary’s hands, irrespective of whether the beneficiary is a resident or a non-resident. It is worth noting that while paragraph 80 refers to the tax residence of trust beneficiaries, sections 25B(1) and (2) contain no distinction based on the residence of the beneficiary.
The Draft Explanatory Memorandum raises concerns about a South African trust vesting income in a non-resident beneficiary, which it says gives rise to challenges in tax collection. To resolve this, Government has proposed an amendment to section 25B(1) and (2) by limiting the flow-through principle to only South African tax resident beneficiaries. In other words, where income vests in a non-resident beneficiary, such income will be taxed in the hands of the trust - at a flat rate of 45%. If such amounts are subsequently distributed to the foreign beneficiary, no further income tax effects would apply. This amendment would thus align the tax treatment of income distributions by trusts to non-resident beneficiaries with the tax treatment of capital gains. This proposed resolution of Government’s tax recovery problem does however have unintended, adverse implications for non-resident beneficiaries.
Consequences of Draft Taxation Laws Amendment Bill of 2023
In determining amounts to be withheld on SA sourced distributions made to non-residents, there is a risk that more withholding tax would be payable, and that such withholdings tax would not be creditable in the jurisdiction of residence of the non-resident beneficiary. The withholding tax payable by non-residents is often subject to the provisions of a Double Tax Agreement (‘DTA’) between SA and the non-resident beneficiary’s resident country. Prior to the proposed amendment, the non-resident beneficiary as the ‘beneficial owner’ of the income could often rely on the DTA to provide a reduction in the withholdings tax percentage applied to the income, for example interest income or dividend income. It appears from the interpretation that SARS places on the term ‘beneficial owner’ as expressed in its Comprehensive Guide to Dividends Tax, that in circumstances in which trustees have exercised their discretion and vested dividends in a beneficiary within the trust’s year of assessment in which the dividend is paid to the trust, it is because sections 25B(1) and (2) currently deem the dividend to have been derived by the beneficiary and not the trust that the beneficiary, and not the trust, is regarded as the ‘beneficial owner’ of the dividend. If this is indeed the reason why the beneficiary is regarded as the ‘beneficial owner’ of a dividend then it implies that if the proposed amendments are made to these sections, the trust would be regarded as the ‘beneficial owner’ of the dividend in these circumstances. The trust will thus no longer simply act as a ‘conduit pipe’ which the income flows through to the non-resident but may be treated as the ‘beneficial owner’ of that income for SA income tax purposes. The reduced rate relief provided by a DTA is only available to the ‘beneficial owner’ of that SA sourced income and, if the trust is seen as the beneficial owner of the income, the non-resident would be unable to enjoy the relief provided by the DTA.
A further problem is that, depending on the tax treatment in the jurisdiction of residence of the non-resident beneficiary, double economic taxation may be suffered on the income vested by the trust. As noted above, as a result of the amendment, the income vested in the non-resident beneficiary will be taxable in the hands of the trust. If the jurisdiction of residence of the non-resident beneficiary applies a residence-based tax system, the non-resident beneficiary may be taxed on the income in that jurisdiction. The principle of residence-based taxation of income envisages the taxation of global income and in the case of the non-resident beneficiary, the income distribution from the SA resident trust would form part of their global income. Where the income is taxed in the hands of trust, the tax would be borne by the trust and not the non-resident beneficiary and the South African tax may therefore not be creditable against the foreign income tax payable by the non-resident beneficiary on the income. The amended provisions of section 25B may thus render the income vested taxable both in South Africa and the jurisdiction of residence of the non-resident beneficiary, without relief. It is possible that relief may be available to the non-resident beneficiary, depending on the wording of the DTA or if the provisions of the tax legislation in the jurisdiction of residency allow for relief in these circumstances.
A further issue with the proposal is that it may hinder the non-resident beneficiary from utilising excess deductions and allowances that are being carried forward from previous tax years, against any future income vested in the non-resident beneficiary by the trust, as provided for in section 25B(6). In the absence of income accruing to the non-resident beneficiary, there would be no income available against which to apply the excess deductions and allowances.
In summary, the Draft Taxation Laws Amendment Bill of 2023 seeks to address issues surrounding tax evasion and the complexities in collecting taxes from non-resident beneficiaries of South African trusts. While the intention behind the proposed amendments are comprehensible, it is crucial for policymakers to thoroughly also consider the unintended consequences, ensuring that the desired objectives are achieved without unduly prejudicing the non-resident beneficiaries. Instead of taxing the trust on such income, it may be preferable to amend the current provisions of the Tax Administration Act relating to withholding agents such that the trust becomes the withholding agent in respect of the tax, with the responsibility to withhold and pay the tax of the non-resident beneficiary to SARS.