The amendments to the Income Tax Act (“the Act”) addresses the issue of South African residents holding shares in a foreign company through foreign trusts. The Taxation Laws Amendment Act, 2018 which was published on 17 January 2019, provides that the amendments are effective from 1 March 2019.
BACKGROUND TO SPECIFIC ANTI- AVOIDANCE PROVISIONS DEALING WITH OFF SHORE TRUSTS AND FOREIGN INCOME:
When residence-based tax system was introduced in 2001, the legislature, mindful of the possibility of avoidance of tax on foreign income using foreign trusts, enacted provisions aimed specifically at preventing such avoidance. They are sections 7(8) and 25B(2A) of the Act and paragraphs 72 and 80 of the Eighth Schedule of the Act.
THE LEGISLATION BEFORE THE TAXATION LAWS AMENDMENT ACT, 2018:
Donor attribution rules:
- Section 7(8) deems any amount to be the income of a resident, if, such amount is received by or accrued to a foreign trust in consequence of a donation settlement or other disposition (including a loan that incurs interest at less than a market-related rate) made by the resident, and, such amount would have been included in income of the foreign trust had the trust been a resident.
- Paragraph 72 of the Eighth Schedule deems a capital gain (or an amount which would have constituted a capital gain had the trust been a resident) arising in a foreign trust to be taxable in the hands of a South African resident who made a donation settlement or other disposition to that foreign trust.
- However, in terms of the participation exemption in section 10B(2)(a) and paragraph 64B, any foreign dividends, and, any gain arising in the foreign trust from the disposal of an asset constituting an equity share of the trust in any foreign company, must be disregarded if, amongst other requirements, the trust held an interest of at least 10 per cent of the equity shares and voting rights in that foreign company.
Capital distributions to a South African resident beneficiary:
Arising out of income:
- Section 25B(2A) provides that, where capital from a foreign trust vests in a resident beneficiary, that amount must be included in the taxable income of that resident if, such capital arose from prior year receipts of the trust, which would have constituted income of the trust if the trust had been a resident, and that resident had a contingent right to that income at the time it was received, and such amount has not already been subject to tax in South Africa. However, the capital of a foreign trust arising from a prior year’s foreign dividends, where the foreign trust holds at least 10% of the equity shares and voting rights in the foreign company, would not be taxable in the hands of the resident beneficiary because of the participation exemption in section 10B(2)(a).
- Paragraph 80(1) provides that where a trust vests an asset in a resident beneficiary, any capital gain must be disregarded in the hands of the trust and must instead be accounted for as a capital gain in the hands of the resident beneficiary. Paragraph 80(2) provides that where a trust disposes of an asset and vests any capital gain in the same year in a resident beneficiary, any capital gain must be disregarded in the hands of the trust and must instead be accounted for as a capital gain in the hands of the resident beneficiary. Paragraph 80(3) provides that, if a foreign trust makes a capital gain, then the distribution of that gain to a resident beneficiary in a later year is taxed in the hands of the resident beneficiary, provided the gain was made during a year in which the resident beneficiary had a contingent right to the capital of the trust and that gain has not been taxed in terms of any other provision of the Act.
- However, in terms of the participation exemption in paragraph 64B, any gain arising in a foreign trust from the disposal of an asset constituting an equity share of the trust in any foreign company, must be disregarded if, amongst other requirements, the trust held an interest of at least 10 per cent of the equity shares and voting rights in that foreign company. Consequently, any capital distributions to a resident from such gains would not be taxed in the hands of the resident.
AMENDMENTS IN TERMS OF THE TAXATION LAWS AMENDMENT ACT, 2018:
The amendments provide that, the participation exemption provided for in section 10B(2)(a) and paragraph 64B must be disregarded, in determining the amount which would have constituted income from foreign dividends or a capital gain of a foreign trust, had the trust been a resident, where:
- the foreign trust, or any one or more connected persons in relation to the trust, holds more than 50% of the total participation rights or voting rights in the foreign company; and
- for purposes of the donor attribution rules in section 7(8) and Paragraph 72, if the foreign dividend, or capital gain, which is derived by the foreign trust, arises from a donation, settlement or other disposition made to the foreign trust by a South African resident donor (or any relative of the donor or any trust of which the donor or relative is a beneficiary) who is a connected person in relation to the foreign trust (eg, a beneficiary or a relative of a beneficiary); and
- for purposes of capital distributions from a foreign trust to a resident, if the resident or any person that is a connected person in relation to that resident is a connected person in relation to that trust.
Disregarding the participation exemptions would mean that, even if a foreign dividend or a gain from the disposal of equity shares in a foreign company would have been exempt in terms of the participation exemption if the trust had been a resident, that foreign dividend and gain would still be taxed in the hands of the South African resident donor or beneficiary where applicable.
The above changes came into effect on 1 March 2019. The amendments are aimed at bringing foreign dividends and capital gains, derived by foreign trusts with South African resident beneficiaries, arising from foreign companies in which the foreign trust holds the majority shares, into the South African tax net. It may be well advised at this stage to determine whether the proposed amendments may be applicable to those South African residents who are beneficiaries of foreign trusts.