Some estate planners and trustees are not aware that a trust is regarded as a separate taxpayer, who has to register as such, and who has to submit relevant tax returns.
The history
Trust income was always taxed in the hands of the trust unless it vested in the hands of the beneficiaries, whereby it was then taxed in the hands of the beneficiaries.
This practice was challenged in the CIR v Friedman case of 1993 on the grounds that the trust was not a taxable entity and, therefore, the trustees were not representative taxpayers. It was held in this case that, under common law, a trust is not a “person”.
This case resulted in the amendment to the definition of “person” in Section 1(1) of the Income Tax Act to include a trust and resulted in the inclusion of Section 25B in the Income Tax Act, which is a regulatory provision in the sense that it determines who will be taxed on trust income, and when, rather than being an anti-avoidance provision.
The principle taxing section for trusts
Section 25B of the Income Tax Act, which is the principal taxing section relating to trusts (subject to the anti-avoidance provisions of Section 7 of the Income Tax Act), provides that the income of a trust is taxed either in the trust or in the hands of the beneficiary as follows:
- If the income vests in a beneficiary during the financial year (ending February each year), then the beneficiary is taxed on it.
- If the income does not vest in the beneficiary, then the trust is taxed on it.
Section 25B of the Income Tax Act (referring to trust income) and Paragraph 80(2) of the Eighth Schedule to the Income Tax Act (referring to trust capital gains), read together with Section 7(1) (income distributed or vested but not yet paid) of the Income Tax Act essentially codified the Conduit Principle first articulated in South African common law.
That means that the Conduit Principle was first used without it being written into the Income Tax Act.
The Conduit Principle can only be used for taxing capital gains in the hands of the beneficiary if the trust instrument specifically gives the trustees the power to distribute a capital gain.
Wording to the following effect will empower the trustees to make a distribution of capital gains, which is an artificial concept in the Income Tax Act:
“…The trustees shall in their sole, absolute and unfettered discretion determine whether any distribution which represents the payment or distribution of any capital profit and/or capital gain arising out of the disposal of trust property, constitutes the vesting of an interest in the capital profit and/or capital gain in respect of that disposal for purposes of Paragraph 80(2) of the Eighth Schedule to the Income Tax Act 58 of 1962, as amended, irrespective of whether the amount actually distributed is lower or higher than the amount of the capital gain determined in respect of that disposal in terms of the Eighth Schedule to that Act.”
Do trusts pay provisional tax?
Trusts do not automatically qualify as provisional taxpayers in terms of Paragraph (1) of the Fourth Schedule to the Income Tax Act. They, therefore, must register with SARS as provisional taxpayers within twenty-one business days of becoming obliged to register – i.e. when they receive ‘income’ (note that this is a broader definition than ‘taxable income’).
Unless the trust distributes all income and/or capital gains in terms of the Conduit Principle discussed above, the trust will be liable to pay provisional taxes on amounts not distributed to beneficiaries or attributed to the funder.
All registered provisional taxpayers must submit a Provisional Tax Return (IRP6) and pay Provisional Tax twice a year in August and February each year. A top-up payment to pay 100% of the taxes due for that year may be made seven months after the year-end in August.
Provisional Tax is the only way that trusts would pay their taxes to SARS during the tax year if they earn taxable income. Although most trusts do not generate taxable income, SARS still requires nil income returns to be submitted.
If the trust does not qualify as a provisional taxpayer, but it derives a capital gain on the disposal of an asset during the year of assessment, then the receipt of the capital gain does not render it a provisional taxpayer.
When are trust tax returns due for submission?
Trust tax return due dates are in alignment with those of individuals. For this year the dates are as follows:
- Trusts that are not Provisional Taxpayers: 1 July 2022 to 24 October 2022; and
- Trusts that are Provisional Taxpayers: 1 July 2022 to 23 January 2023.
Phia van der Spuy is a Chartered Accountant with a Masters degree in tax and a registered Fiduciary Practitioner of South Africa®, a Chartered Tax Adviser, a Trust and Estate Practitioner (TEP) and the founder of Trusteeze®, the provider of a digital trust solution.
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