South African families who have created a trust in South Africa may be living in another part of the world. It is important to understand the tax rules and other implications for foreign beneficiaries.
Where do trusts pay tax?
Trusts are taxed in South Africa if they were formed or established in South Africa. They are also taxed in South Africa if they are foreign trusts but are managed in South Africa. If a foreign trust holds assets, such as property, in South Africa, the trust is required to register with the South African Revenue Service for tax purposes. Foreign trusts, therefore, are taxed on a “source” basis; on such income and not on a “residence” basis.
These rules may result inlead to a trust – whether South African or foreign trusts – being taxed in more than one jurisdiction. South Africa has entered into treaties with various countries that determinein order to agree in which one country a trust will pay tax. In most cases, the country in which a trust is managedThe place of effective management of the trust will in most instances determine where the trust pays tax.
According to the Income Tax Act, a South African-registered trust is defined as a South African resident. TheOECD Organisation for Economic Co-operation and Development (OECD) treaty takes this one step further and states that if a trust is registered in South Africa but conducts its business, or earns its income and capital gains offshore, it is still deemed a resident of South Africa and will be taxed in South Africa. Furthermore and conversely, the OECD treaty states that if the trust is managed in South Africaeven if it is registered offshore, it is deemed a South African resident, even if it is registered offshore, and will be taxed in South Africa.
South Africa is one of the many non-member countrieseconomies with which the OECD has a working relationship, in addition to its 34-member countries.
How are South African residents taxed on income distributions to foreign beneficiaries?
If a South African discretionary trust distributes an amount to a non-resident beneficiary as a result of a donation, settlement or other similar (gratuitous) disposition, such as a soft loan, made by a South African resident, and this amount would have been included in the non-resident beneficiary’s income if he or she had been a resident, such amount will be deemed to be income in the hands of the South African resident donor or funder and included in his or her taxable income.
If an asset is disposed of for less than its market value, the difference between the selling price and the market value will be deemed a donation. The resulting income on the difference between the selling price and the market value will be treated the same way as above.
Where there is an expense, allowance or loss that the foreign beneficiary could have claimed as a deduction from the income (if he or she had been a resident in South Africa), such expense, allowance or loss is deemed to have been incurred by the donor or funder, but is limited to the amount of income distributed. As a result, a loss cannot be created from such deductions.
If a non-resident paid foreign tax on the same amount (which actually accrued to him or her), the South African donor or funder may deduct a rebate equal to the foreign tax that has been paid.
How are South African residents taxed on capital gains distributions made to foreign beneficiaries?
Where a South African discretionary trust distributes a capital gain to a non-resident beneficiary, the South African resident donor or funder who made the donation, settlement or other similar (gratuitous) disposition (such as a soft loan) – not the non-resident – will be taxed on the capital gain that results from the disposition.
If a non-resident paid foreign tax on the same amount (which actually accrued to him or her), the South African donor or funder may deduct a rebate equal to the foreign tax paid.
Other tax implications
It is important to understand whether other countries may tax foreign beneficiaries on South African trust income, apart from the taxes discussed above. Trustees need to do a proper assessment of beneficiaries to understand and plan for any possible negative international tax consequences.
Exchange control implications
A South African trust runs the risk of being classified as an “affected person” if it has foreign beneficiaries.
An affected person is a body corporate, foundation, trust or partnership operating in South Africa, or an estate in respect of which either:
75% or more of its capital, assets or earnings may be used for payment to, or to the benefit in any manner of, a non-resident; or
75% or more of its voting securities, voting power, power of control, capital, assets or earnings are directly or indirectly vested in, or controlled by or on behalf of, a non-resident.
“Affected persons” may obtain financial assistance in South Africa subject to certain restrictions. Financial assistance includes taking up securities, granting credit, lending currency, discounting, factoring and guaranteeing or acceptance any obligation. In other words, if the trust needs to borrow money, it may be restricted.
A possible way to counter the negative effect of a trust being labelled an “affected person” is for the trust deed to include a clause stipulating that if a non-resident beneficiary’s participation in allocations, payments or applications for his or her welfare results in the trust, or any company or other entity in which the trust has a direct or indirect interest, being classified as an “affected person” for the purposes of the exchange control regulations, the trustees may, by unanimous decision, restrict such a beneficiary’s participation in allocations, payments or applications for his or her welfare, to avoid such classification, treatment, preclusion or restriction, with the right to reinstate such person’s participation when the restrictions are no longer necessary or operative.
Be aware of the implications
It is important to be aware of the tax and other implications of non-resident beneficiaries of South African trusts. Always use the services of a professional to draft your trust deed. It may be wise to appoint an independent trustee who can guide the other trustees on technical issues such as those described above.
Phia van der Spuy is a registered Fiduciary Practitioner of South Africa and the founder of Trusteeze, which specialises in trust administration, and the author of Demystifying Trusts in South Africa (Createspace).