Taxation of Trusts

Taxation of Trusts in South Africa: A Complete Legal and Practical Guide

Understanding the Taxation of Trusts

The taxation of trusts in South Africa is a complex but crucial aspect of wealth management, estate planning, and compliance under the Income Tax Act 58 of 1962. A trust is a legal arrangement where assets are held by trustees for the benefit of beneficiaries. While trusts offer strategic benefits such as asset protection and succession planning, they are subject to specific and often stringent tax provisions.

Under the Income Tax Act, trusts are recognized as separate taxpayers and are generally taxed at a flat rate. However, the actual tax implications depend on various factors including the type of trust, income distribution, the nature of beneficiaries, and whether the trust is a discretionary or vested trust. Key statutory provisions, particularly sections 7 and 25B, heavily influence how trust income is taxed.

Understanding the taxation of trusts is critical for both trustees and beneficiaries, as non-compliance can result in significant penalties under anti-avoidance rules.

How Trusts Are Taxed in South Africa

The general principle of taxation of trusts in South Africa is that trusts are taxed at a flat rate of 45% on taxable income, which is significantly higher than the progressive tax rates applied to individuals. This flat rate is set out in the First Schedule to the Income Tax Act 58 of 1962.

However, this principle is nuanced by the application of section 25B and section 7, which allocate trust income differently under specific conditions.

If income is distributed to beneficiaries in the same year it accrues, the income is “flowed through” to the beneficiary and taxed in their hands, often at a lower individual tax rate. This is known as the conduit principle, reaffirmed in CSARS v Woulidge 2002 (1) SA 68 (SCA).

Section 25B of the Income Tax Act: Income Attribution

Section 25B governs how income earned by a trust is taxed. If a trust receives income and that income is vested in a beneficiary within the same tax year, it is not taxed in the hands of the trust but in the hands of the beneficiary.

This principle was examined in Meyerowitz on Income Tax, where it was confirmed that section 25B operates to avoid double taxation and allows for tax efficiency through beneficiary distributions.

To benefit from section 25B, proper accounting and trustee resolutions are essential. Failure to vest income timeously results in taxation at the trust level.

Section 7 and Anti-Avoidance Provisions

Section 7 is an anti-avoidance provision intended to prevent income splitting and tax arbitrage using trusts. It attributes income back to the donor (the person who transferred assets to the trust) under various scenarios. These include:

• Section 7(1): Revocable transfers

• Section 7(2): Right to control or direct the income

• Section 7(3)–(6): Donations with conditions or for minor children

This attribution overrides section 25B when applicable. For example, in SIR v Rosen 1971 (1) SA 172 (A), the court held that income allocated to a minor child could still be taxed in the hands of the donor under section 7(3).

Thus, the interplay between section 7 and 25B of the Income Tax Act is pivotal in the taxation of trusts and requires careful planning.

South African Trust Income Tax Rules and Capital Gains

Beyond income tax, capital gains tax (CGT) is a vital part of the taxation of trusts. Trusts are taxed at an effective rate of 36% on capital gains (80% inclusion rate multiplied by 45% trust rate).

Where capital gains are vested in a beneficiary, the gain may be taxed in their hands at a lower rate—this is another aspect of the conduit principle. The relevant provision here is paragraph 80 of the Eighth Schedule to the Income Tax Act.

Trusts can therefore be used to optimize CGT liabilities if distributions are properly structured and documented.

In Estate Dempers v CIR 1977 (3) SA 410 (A), the court recognised the legitimacy of CGT planning in estate and trust arrangements, provided there is no abuse.

Tax Benefits of Discretionary Trusts

Discretionary trusts offer strategic tax planning benefits due to the flexibility in income and capital allocation. Trustees have the discretion to decide which beneficiaries will receive income or capital, and in what proportions.

This discretion allows for:

• Splitting income among beneficiaries

• Timing distributions to reduce tax exposure

• Using minor or low-income beneficiaries to minimize overall tax burden

However, these advantages are often scrutinized by SARS. In Crookes NO v CSARS 2020 ZASCA 40, the court warned that discretionary trusts used primarily to avoid tax could face legal consequences under the General Anti-Avoidance Rule (GAAR) contained in section 80A–L of the Income Tax Act.

Therefore, while tax benefits of discretionary trusts are legitimate, they must be supported by economic substance and lawful purpose.

Practical Strategies for Managing Taxation of Trusts

Effective trust tax planning begins with understanding the nature of the trust and its purpose. Here are core elements to consider when managing the taxation of trusts:

Maintain detailed records of all trustee meetings, decisions, and resolutions to support distributions.

Ensure timely vesting of income if relying on section 25B to tax income in the hands of beneficiaries.

Use tax-exempt beneficiaries, such as Public Benefit Organisations (PBOs), where applicable, to reduce trust tax liabilities.

Where permissible, loan accounts and interest-free loans can be structured, keeping in mind SARS’ recent crackdown on interest-free loans to trusts through section 7C.

Reinvest capital gains in ways that defer realization, using asset holding strategies that stagger CGT events.

Compliance with the Trust Property Control Act 57 of 1988 is also essential for governance and accountability.

Trust Tax Avoidance Penalties in South Africa

SARS has broad powers to investigate and penalise abusive trust arrangements. Trusts that are used primarily to avoid tax may fall foul of:

• General Anti-Avoidance Rule (GAAR) – sections 80A to 80L

• Understatement penalties – section 222 of the Tax Administration Act 28 of 2011

• Administrative non-compliance penalties

Penalties can range from 25% to 200% of the tax avoided, depending on the taxpayer’s conduct. In CSARS v NWK Ltd 2011 (2) SA 67 (SCA), the court held that a scheme without commercial substance may be disregarded for tax purposes.

Hence, trustees and donors must exercise caution when using trusts as tax minimisation vehicles.

FAQ: Taxation of Trusts in South Africa

Is a trust a taxpayer in its own right in South Africa?
Yes. A trust is a separate legal taxpayer under the Income Tax Act and is generally taxed at a flat rate of 45%.

What is the conduit principle in the taxation of trusts?
The conduit principle allows income and capital gains to be taxed in the hands of beneficiaries if vested in them in the same year.

How do section 7 and section 25B of Income Tax Act work together?
Section 7 overrides section 25B where income is deemed to be from a donation with reserved interest or control, thereby taxing the donor.

What is the tax rate for capital gains in a trust?
Trusts pay an effective CGT rate of 36%, but this can be reduced through beneficiary allocations.

Can I reduce trust tax by distributing income to beneficiaries?
Yes, provided the income is vested in the beneficiaries during the same year and properly documented.

What happens if income is not distributed from a trust?
Undistributed income is taxed in the hands of the trust at 45%, which is higher than most individual rates.

Are there penalties for using trusts to avoid tax?
Yes. GAAR, understatement penalties, and other provisions apply to abusive trust structures.

Is interest on loans to trusts taxable?
Yes. Under section 7C, interest-free loans to trusts are subject to deemed donation provisions.

Can trusts be used for tax evasion?
No. Using a trust to illegally evade tax can result in severe penalties and criminal prosecution.

What records must trustees keep for tax purposes?
Trustees must keep financial statements, distribution resolutions, tax filings, and communication records.

References Table

Useful Links

• SARS Trusts Tax Guide
  Offers official guidance on how trusts are taxed, forms, and submission procedures.

• National Treasury – Tax Policy Documents
  Provides fiscal updates affecting trust tax rates and planning.

• South African Institute of Taxation (SAIT)
  A credible resource for developments, seminars, and commentary on trust taxation.

If you would like to know more about establishing property trusts, specifically click here. 

For Ante-nuptial contracts click here.

For Post-nuptial contracts click here. 

For the Post-nuptial execution of an Ante-nuptial contract click here. 

For estate planning in general click here. 

For legal restrictions in wills click here.

If you would like to know more about power of attorneys click here.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for errors, omissions, loss, or damage arising from reliance upon any information herein. Don’t hesitate to contact Meyer and Partners Attorneys Incorporated if you require further information or specific and detailed advice. Errors and omissions excepted (E&E).

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