Foreign trust beneficiaries – beware of the tax considerations - 5 September 2024

Foreign trust beneficiaries – beware of the tax considerations

Over the years, several South African trust beneficiaries ceased to be South African tax residents, and others never were. Many South African families also created international structures as part of their estate plans. The South African Revenue Service (SARS) had to adapt its taxation laws to accommodate these changing circumstances to collect taxes efficiently. Especially since March 2019, significant changes were made to the Income Tax Act (the Act) relating to the taxation of income and capital gains earned by foreign resident trusts, foreign companies held by foreign resident trusts, distributions made to foreign resident beneficiaries from both South African and foreign resident trusts, and distributions made to South African resident beneficiaries from foreign resident trusts. Some years ago, SARS introduced measures to ensure they collect taxes on capital gains generated in South African trusts in South Africa rather than having to pursue a beneficiary sitting overseas to collect its taxes. It would be particularly difficult for SARS to collect taxes if distributions are made to foreign trusts, who are beneficiaries of South African trusts, as SARS most probably do not have information on the persons in whom those foreign trusts vest amounts taxable in South Africa. SARS, only effective from 1 March 2024, aligned the tax treatment of income and capital gains distributions/vestings to non-South African tax resident beneficiaries. Therefore, from the 2025 trust tax year (ending February 2025), the “conduit principle” (subject to the “attribution rules” discussed below) allows for distributions/vestings of income and capital gains to be taxed in the hands of the beneficiaries instead of the trust only if distributions are made to South African tax resident beneficiaries. No longer can accountants and tax practitioners advise their clients to blindly distribute/vest trust income and capital gains to/in beneficiaries to pay little or no tax without knowing/considering their tax residency. Some South African trust beneficiaries may even inadvertently have ceased South African tax residency and will also be impacted by these tax measures.

First, apply the “attribution rules”

Amounts distributed by a South African trust to a foreign resident beneficiary will be taxed in the hands of the South African resident individual if they can veto distributions or manoeuvre distributions to manipulate the amount of tax payable (including changing beneficiaries (South African resident and foreign beneficiaries with vested rights, as well as discretionary beneficiaries)), or terminate the trust, in terms of Section 7(6) of the Act (for income) and Paragraph 71 of the Eighth Schedule to the Act (for capital gains).

The distribution/vesting of income/capital gains (resulting from assets donated or funded by South African resident individuals to South African trusts) by those trusts to the donor/funder’s foreign resident minor child – either in total on assets donated to the trust, or limited to a notional amount of interest calculated (at a market-related interest rate) on the loan if the assets were sold to the trust on a soft-loan basis or funding was provided to the trust to acquire the assets – will be taxed in the hands of the parent in terms of Section 7(3) of the Act (for income) and Paragraph 69 of the Eighth Schedule to the Act (for capital gains).

It is clear that upon the death of the South African resident individual, the provisions of Section 7(6), Section 7(3), Paragraph 69 and Paragraph 71 would no longer apply. Although it is believed that Section 7(3) does not apply after the death of the funder-parent, there are certain possible exceptions. Where the funder-parent is married in community of property, the income accruing to a minor child will be equally attributed to each of the parents as a result of the gratuitous disposition from their joint estate. If one parent dies, Section 7(3) will, therefore, continue to apply to the surviving parent. It is also argued that where the loan account is bequeathed to a surviving parent, and the income continues to accrue to a minor child, the income may continue to be attributed to the surviving parent, in terms of Section 7(3) (Commissioner of Inland Revenue v Berold case of 1962). Until SARS clarifies their position, estate planners should be mindful of potential material implications and uncertainty when doing estate planning and when dealing with such loans in their wills.

Any resultant income and capital gains distributed to foreign resident beneficiaries – after the application of the “attribution rules” will always be taxed in the hands of the trust.

Distributions by South African trusts to foreign trusts

Historically, South Africans experienced difficulties paying distributions to foreign trusts, as it has been a practice of SARS not to approve the release of funds when resident trusts make distributions to non-resident trusts. That made it impossible for trustees to pay such foreign beneficiaries resulting from historical distributions, even though the founder intended to benefit such beneficiaries. Therefore, on  1 August 2023, SARS issued an update on the distribution of funds to non-resident trusts by resident trusts, whereby they confirmed that it would consider approval for releasing funds/amounts distributed to non-resident trusts, subject to specific requirements having been met. The process described on eFiling seems uncomplicated and a carte blanche for South Africans to move large amounts from their South African trusts to foreign trusts.

The approval process requires trustees to apply for a manual compliance letter at SARS by emailing MLCA@sars.gov.za. Before a letter of compliance will be issued, the following requirements have to be met:

• The non-resident trust must be included in the trust instrument’s definition of “beneficiary/ies” as a named beneficiary or as part of a class of beneficiaries.
• Any relevant terms, conditions and processes relating to distributions in the trust instrument of the resident trust have to be complied with.
• SARS will perform verification processes to ensure that strict interpretation of the relevant sections of the Act is complied with.
• The resident trust should demonstrate that all tax liabilities regarding the distribution were or will be settled, as discussed above.
• SARS expressly refers to specific required Supporting Documents for Approval of International Transfers (AIT). Supporting documents proving source(s) of the total value of the Approval of International Transfer resulting from distributions will have to be submitted to SARS, including:
  • Copy of the trust instrument
  • Copy of the latest Letters of Authority
  • Resolutions by the trustees of the resident trust making the distributions
  • Details of the source(s) of funds distributed by the trust
  • Bank statements of the applicant relating to the AIT application (issued no longer than 14 days before the date that the AIT application is submitted)
  • The trust’s most recent share portfolio statement (not older than a month). This statement must include a description, the number of and current market value of the shares
  • The most recent financial statements/annual financial statements of the trust

SARS has noted that the South African Reserve Bank has relaxed certain exchange control requirements but has decided, based on the risks involved, to introduce the requirements mentioned above to mitigate the risks. SARS indicated that Reserve Bank approval may still be required.

It would, therefore, be unwise and reckless to advise any client to blindly close down their South African trust/s and opportunistically move all their money offshore. There is a bit more to it.

Tax treatment of country of residence

Many countries take a hostile view of foreign trusts, and many civil law countries do not recognise the concept of a trust. Therefore, a beneficiary of a South African resident trust who is resident in another part of the world can end up in an unintended messy tax predicament. If a beneficiary of a South African resident trust intends to move abroad for any significant length of time, or even permanently, it is important to enquire about that country’s tax treatment of a discretionary South African resident trust beneficiary and seek the necessary advice before the beneficiary takes up residence outside South Africa.