The comments in this article are based on SARS Binding Private Ruling: BPR50
- WHAT IS THE STATUS OF A BINDING PRIVATE RULING (“BPR”) BY SARS?
- The Tax Administration Act 28 of 2011 provides for a process whereby a taxpayer can apply to SARS for an advance tax ruling on a transaction that is still to be concluded in the future. The purpose of this system and the BPR is to promote clarity, consistency and certainty regarding the interpretation or application of one of the tax acts administered by SARS, such as for instance the Income Tax Act.
- The ruling will be binding on SARS when you are assessed in connection with the proposed transaction, unless you have not disclosed all the facts in connection with your proposed transaction or have not concluded the transaction as described in your application.
- It is very important to note that a BPR may not be cited in any proceeding before SARS or the courts, other than a proceeding involving the taxpayer applicant. You cannot therefore rely upon a binding ruling that has been issued to someone else, even if the facts of the proposed transaction are similar to those described in the published ruling.
- The BPR does however provide more clarity on how SARS is likely to interpret any particular provision of a tax act.
- WHAT TAX QUESTION DID BPR350 APPLY TO?
- The BPR relates to the tax treatment of the vesting of a capital gain in a beneficiary of a trust where payment of the capital gain is deferred at the discretion of the trustees and the capital gain is invested on behalf of the beneficiary.
- APPLICABLE LEGISLATION
(Section 7C of the Income Tax Act (“ITA”) and paragraph 80(2) of the 8th Schedule to the ITA)
- Section 7C of the ITA came into operation on 1 March 2017. The section provides that if a natural person makes a loan to a trust to which he is connected, a donation will arise if the interest rate on the loan is less than the official interest rate as stipulated by SARS. It applies to any loan, advance or credit provided by a South African resident individual to a trust before, on, or after that date. The section was extended with effect from 19 July 2017 to a loan made by an individual to a company in which such trust (or a beneficiary of that trust) holds at least 20% of the equity shares or is able to exercise 20% of the voting rights.
- The amount of the donation is calculated as follows: Amount of the loan x (interest at the official rate minus actual interest charged) = donation.
- This deemed donation is then subject to donations tax at 20%.
- Paragraph 80(2) of the 8th Schedule to the ITA deals with capital gains realized in trusts and provides that where a trust disposes of an asset and makes a capital gain, it is not taxed on the gain if it vests the gain in a South African resident beneficiary. The beneficiary is taxed on the gain instead at the individual tax rates, which are much lower than the rates applicable to a trust.
- FACTS UPON WHICH THE BPR ARE BASED
- The trustees proposed that an investment of the trust must be disposed of. This disposal will result in a capital gain which the trustees wants to award to a beneficiary.
- The trust deed provided the unilateral power to the trustees to credit a vested capital gain to the account of the beneficiary or to otherwise deal with it without actual payment of an amount or delivery of an asset to the beneficiary.
- The trustees will then unilaterally invoke their powers to defer enjoyment of this amount to a date to be determined in the sole discretion of the trustees.
- The beneficiary will play no role in the decision to be made by the trustees to defer the enjoyment of the vested amount. The beneficiary will not make any loan or credit to the trust and will not conclude any agreement with the trustees in this regard.
- The trustees will invest the vested amount on behalf of the beneficiary for his benefit and the income arising from such investment will accrue to the beneficiary and not to the trust.
- The trustees will keep accurate records of the vested amount, to which enjoyment has been withheld, and will therefore need to track and identify the amount so vested and the income that it yields. Any assets acquired on behalf of the beneficiary with the vested amount will be accounted for and recorded by the trustees in the financial records of the trust.
- The beneficiary has the right to alienate the award and to offer it as security.
- The last date for payment of the award, if it is not paid out earlier, is the date of death of the beneficiary.
- SARS RULING
- SARS made the following ruling as to the applicability of Section 7C and paragraph 80(2) based on the aforementioned facts:
- Paragraph 80(2) will apply and the capital gain must be disregarded for the purpose of calculating the aggregate capital gain or loss of the trust and must be taken into account for the purpose of calculating the aggregate capital gain or loss of the beneficiary.
- Section 7C will not apply to the proposed transaction.
- Any subsequent income earned on the vested amount, or such income as will be apportioned to the vested amount, to which enjoyment has been withheld, will accrue to the beneficiary and must be included on the gross income of the beneficiary.
- In Claassen’s Dictionary of Legal Words (LexisNexis Electronic law library), the word “vest” is defined as follows:
“Unfortunately the word vest bears different meanings according to its context. When it is said that a right is vested in a person, what is usually meant is that such person is the owner of that right – that he has all right of ownership in such a right including the right of enjoyment. If the word vested were used always in that sense, then to say that a man owned a vested right would mean no more than that a man owned a right. But the word is also used in another sense, to draw a distinction between what is certain and what is conditional; a vested right as distinguished from a contingent or conditional rights” (per WATERMEYER, JA in Jewish Colonial Trust v Est Nathan 1940 AD 175). As to the use of the word vest in a will, see Samaradiwakara v De Saram 1911 AD 469. “The question whether rights are vested or not arises most frequently in relation to rights conferred by a will, and when employed in that relation, the expression ‘vested right’ usually denotes a right whose actual enjoyment, although it may be deferred, is not dependent upon any contingency” (In re Allen Trust 1941 NPD 156). See CIR v Est Bews 1943 NPD 327; Ex parte Dickens: In re Dugmore’s Will 1944 GWLD 60; Smith v Est Smith 1949 1 SA 534 (A); Ex parte Schroder 1956 2 SA 152 (E); Est Watkins-Pitchford v CIR 1955 2 SA 447 (A); Schaumberg v Stark 1956 4 SA 467 (A); Die Meester v Meyer 1975 2 SA 1 (T) 8 9; Ex parte Parker 1968 1 SA 253 (C).
- In the context of a trust, it may well be argued that the vesting of a benefit in a beneficiary is similar to those instances where the courts had to define the term “vest” in relation to a will, and it would ultimately mean that a beneficiary’s vested right in trust assets denotes a right whose actual enjoyment, although deferred, is not dependent upon any contingency such as the exercise of the trustee’s discretion. Therefore, before vesting has taken place, the beneficiary’s right is subject to a contingency, namely the exercise of the trustee’s discretion, but once vesting has taken place, the beneficiary has a claim against the trust which is merely deferred in accordance with the terms of the trust deed, but is no longer subject to the trustee’s discretion.
- In our opinion, SARS was correct in its interpretation of paragraph 80(2) to the stated facts. The paragraph is very clear and requires vesting of the capital gain in the beneficiary and not payment It therefore seems that, as long as the trust deed provides for vestment of a capital gain in a beneficiary as well as the right to defer payment thereof, the paragraph should be applicable and the capital gain will be taxed in the hands of the South African resident beneficiary at their own marginal income tax rate.
- When Section 7C first came into operation, it was argued by trust and tax specialists that any income or capital gain which is vested in a beneficiary but not paid out to that beneficiary (in other words it is retained in the trust) will be deemed as an amount outstanding on loan account to that beneficiary, and as such Section 7C will potentially find application. This argument most probably stems from the wording of many trust deeds which provides that the trustees shall be entitled either to transmit the award made to the beneficiary, or to credit his loan account in the books of the trust.
- The BPR however indicates that, if the transaction is treated in the correct manner, SARS may well not regard it as a “loan, advance or credit” made by the natural person to the trust and, as such, the deemed donation rules of Section 7C will not apply.
- The term “loan, advance or credit” is not specifically defined in the ITA. If one therefore looks at the normal meaning of the term “loan”, is it clear that it requires an agreement between the lender and the borrower. (https://www.investopedia.com/terms/l/loan.asp#:~:text=A%20loan%20is%20when%20money,such%20as%20a%20credit%20card.) A loan cannot be a unilateral act.
- If one now considers the situation where the trustees, based on the powers given to them in the trust deed, take a unilateral resolution to vest certain amounts of income or capital gain in a particular beneficiary but to postpone the payment thereof, it is clear that there is no agreement which can constitute a loan or an advance made by the beneficiary to the trust. As such, we are in agreement with SARS that, based on these facts, the amount outstanding on the beneficiary’s account will not fall within the ambit of Section 7C.
- This situation, however, may well be very different in circumstances where the beneficiary was given the choice whether payment should be made or not. If a beneficiary decided that the vested amount should remain in the trust, it may very well constitute a loan or advance made by the beneficiary and SARS will be able to apply Section 7C thereto. Another possibility is where the trust deed provides that a vested amount must only be kept in the trust until a beneficiary reaches a certain age – if the trustees after that date and with the consent of the beneficiary keep these amounts in the trust, it may also bring the transaction into the Section 7C ambit.
- Trustees must therefore very carefully consider the powers they are given in the trust deed as well as the wording of the resolution in terms whereof the distribution is made if they wish to avoid the consequences of Section 7C.
- The final aspect that should be considered is the other tax effects the vesting of the capital gain or income in a beneficiary will have. It should be noted that the facts upon which the BPR is based specifically stated that the trustees intend to invest the amount on behalf of the beneficiary and to keep record of such investment and to account towards the beneficiary for income earned on the investment of the vested amount. In terms of the BPR, any income that is earned in the future on the vested amount, or any income which can be apportioned thereto, will be deemed as gross income in the hands of the beneficiary and will be taxed as such even if payment thereof is also withheld by the trustees.
- As Section 1 of the ITA defines “gross income” as the total amount in cash or otherwise, received by or accrued to or in favour of that resident, it seems reasonable that any income earned on the vested amount will be income in the hands of the beneficiary.
- The question therefore arises: what will happen if the trustees vested an amount of capital gain or income in a beneficiary without specifying that it is a particular asset or keeping it separate from the rest of the trust funds? Will the trustees now be able to simply never declare any income on this vested amount, and thereby avoid further tax consequences in respect thereof? In our opinion these questions will in all probability be answered in the negative. Although SARS has indicated that Section 7C will not be applicable, it is unlikely that they will simply accept that no income is being earned on the vested amount. It will therefore, in our opinion, be necessary for the trustees to take a properly worded decision on what assets and in what form it is vested in a beneficiary. Any income subsequently earned in respect of those vested assets will accrue to the beneficiary, and if no income is declared it will in all probability be necessary to prove that such an asset did not yield income.
- This means that the amount vested in the beneficiary will continue to grow within the trust although the trust will not be taxed on such amounts. This also means that the trustees will need to keep very careful record of amounts vested and how these amounts are invested and what income is earned in respect thereof.
- The Estate Duty Act 45 of 1955, in Section 3(1), states that for the purposes of the act the estate of a person shall consist of all property of that person as at the date of his death and of all property which in accordance with the act is deemed to be the property of the deceased. “Property” is then defined in Section 3(2) as any right in and to property, movable or immovable, corporeal or incorporeal, and includes any fiduciary, usufructuary or other like interest in property. Based on this definition, it would be hard to argue that the trust benefits vested in the deceased beneficiary is not property for the purposes of the Estate Duty Act.
- Even though the benefits may be subject to the terms of the trust deed and therefore not payable to the deceased estate directly, it will in all probability qualify as “property” for purposes of estate duty. This may lead to unforeseen taxes and liquidity in a deceased estate if not taken into account during a person’s estate planning.
- This also means that any person older than 16 years who has rights vested in him by the trustees of a trust, must have a properly drawn last will and testament to provide for these benefits and ensure that same do not devolve in terms of the Intestate Succession Act, which can lead to some unforeseen and undesirable consequences.
- Although this decision by SARS is welcomed and, in our opinion, aligns with the legislation, it also highlights the potential pitfalls faced by trustees when deciding whether to vest any income or capital gains in a beneficiary without actually paying it out. It must always be remembered that, where a trust is used as part of a person’s personal estate planning, it is not used for tax planning alone but also to provide for other benefits such as generational wealth building, asset protection and family succession planning.
- Although the short-term tax benefits of vesting a capital gain or income realized in the trust may be substantial, it will have the effect of placing that asset back into the hands of the beneficiary for income tax and estate duty purposes. This largely negates the purpose of generational wealth building, as the assets will now be subject to taxes upon the death of the beneficiary.
- Depending on the wording of the trust deed and the resolution taken for distribution, the vesting of assets directly in beneficiaries may also negate the benefit of asset protection. For instance, in the BPR’s facts the beneficiary had the right to alienate the award and to provide it as security. This opens up the trust assets for claims by beneficiary creditors, thereby losing one of the main benefits of using the trust.
- Trustees must therefore always carefully consider and weigh the short-term tax savings against the effect a vesting may have on the long-term objectives of the trust.
Should you further be uncertain about your estate planning, please feel free to contact our office to consult with one of our experienced fiduciary specialists.
LLB; LLM (Estate Planning)
Fiduciary and Commercial Department
Phone: 012 361 9823