South Africa: new treatment introduced for trust distributions to non-tax residents
The South African Income Tax Act was amended to align the tax treatment of income distributions from trusts to non-resident beneficiaries with the tax treatment of capital distributions. For years of assessment commencing on or after 1 March 2024, the ‘flow-through’ principle will be limited only to distributions made to South African tax resident beneficiaries.
The explanatory memorandum accompanying the amendment said the gradual relaxation of exchange control regulations had led to an increase in applications to the South African Revenue Service (SARS) for confirmation of tax compliance status for purposes of transferring funds offshore via authorised dealers.
The government said it was concerned by the difference between the rules covering the normal tax treatment of income attributed to beneficiaries of trusts in section 25B of the Act and the rules covering the tax treatment of capital gains in relation to beneficiaries in paragraph 80 of the Eighth Schedule to the Act.
Previously income earned in a trust, whether interest, dividends or rental income, could either be retained by the trust or distributed to its beneficiaries. If retained by the trust, the income was taxed in the hands of the trust at a fixed rate of 45%. But if a trust distributed the income to beneficiaries – regardless of their residency – in the same year it was earned, the ‘flow through’ principle provided that the income could retain its nature and be taxed in the hands of the beneficiary at the beneficiary’s marginal rates of income tax.
For capital gains, however, the tax residency of beneficiaries was relevant. Capital gains distributed by a trust to South African tax resident beneficiaries in the same tax year were taxed in the hands of the beneficiaries at their individual capital gains tax rates, up to a maximum of 18%. But if a trust did not distribute the capital gain or it was distributed to a non-South African tax resident beneficiary, it would be taxed in the hands of the trust at a fixed rate of 36%.
SARS said the flow through of amounts by South African trusts to non-residents placed it in a difficult position to collect income tax from beneficiaries because they might not be taxed on foreign-sourced amounts and recovery actions could be difficult. In the case of non-resident trusts that were beneficiaries, SARS might not have information on the persons to which income was distributed.
Under the Taxation Laws Amendment Act, s.25B of the Income Tax Act has therefore been amended to limit the flow through principle only to resident beneficiaries in line with the provisions of paragraph 80 of the Eighth Schedule.
The difference in the new treatment could have significant implications for non-South African tax resident beneficiaries when distributions are made by South African trusts. It is therefore essential that non-resident trust beneficiaries should clarify their tax residency status as soon as possible.
These changes could also have significant unintended tax implications in respect of untriggered testamentary trusts provided in wills. If the testator’s children have, or are likely to, relocate abroad and cease South African tax residence then the efficacy of such a structure should be reviewed.
