Response to Davis Tax Committee report on Estate Duty

© Vitaliy Vodolazskyy – 123RF.com

Tax proposal

The Davis Tax Committee has made the following proposals:

• Retain the flat rate of taxation for a Trust at the existing levels, currently 41%;
  
• Repeal the provisions of sections 7 and 25B of the Income Tax Act (the Act) which effectively render the Trust transparent for tax purposes; and
  
• Tax Trusts as separate taxpayers. The only relief to the rules should be for a 'special Trust' as defined in the Act. That is a Trust created solely for the benefit of one or more persons with a disability. No plans should be made to implement any transfer pricing adjustments in the event of financial assistance or interest-free loans being advanced to Trusts.

Rebuttal

If the current attribution rules, as set out in the Act, are deleted this will result in a South African Trust being taxed at marginal rate of 41% and a capital gains inclusion rate of 66.6%. This seems to be excessively high - and even discriminatory - if compared to other South African tax-paying entities. Although this is the current rate applicable to Trusts, it is not as harsh in practice, given that Trusts have the flexibility to distribute income and gains between the funder, its beneficiaries and the Trust itself.

In our view, the current manner in which Trusts are taxed should, as far as possible, be retained. Furthermore, we believe that it is not the manner of taxation, which is the mischief but rather the non-compliance and lack of transparency that may be the real issue.

If the current taxation basis of Trusts is to be amended, it would be likely to result in a decline of the use of Trusts. While this may be the desired result from a fiscal perspective, it will negate the real commercial reasons for the existence and use of Trusts.

Misadministration at root

What is the real mischief the fiscus is seeking to address? By simply invoking a harsh tax regime on Trusts, will this address the issue or increase revenue on a sustainable basis? We believe that the real mischief at play is really the lack of administrative efficiency, non-transparency and a delay in the collection of taxes.

With the current common reporting standards, as cemented via the Organisation for Economic Co-operation and Development (OECD) and the Foreign Account Tax Compliance Act (FACTA), having gained momentum internationally, this legislation could simply be extended to local Trusts.

Professional Trust houses, providing independent trustee services, are already geared for compliance with the new proposed reporting standard. If the local fiscus applies similar legislation with a domestic focus, then such implementation will simply be an extension of systems recently geared towards international compliance. This would ease the path to income distribution transparency and full administrative compliance.

The Act is already geared towards the earlier collection of taxes, specifically provisional tax and employees' tax. In most instances, the provisional tax system already applies to Trusts, its funders and its beneficiaries. Furthermore, the Trust's latest income tax return already goes a long way towards disclosing, among others, commercial transactions to and with the Trust and amounts distributed to beneficiaries.

Simple solution

Maybe a simple solution would be to place an administrative requirement on trustees to issue 'certificates' (similar to that of the IRP5) to beneficiaries when income and/or capital gains and/or other non-cash benefits are distributed. On distribution date, a withholding tax equal to the eventual tax rate payable by the said beneficiary or funder could be paid to SARS. At the time when such a beneficiary or funder submits his or her income tax return - the taxes on Trust distributions will have been paid and the said person can simply claim a 'credit' for withholding taxes already paid.

In short, we believe that the fiscus already has the systems and legislation in place and simply needs to refine these to apply to the administration requirements for Trusts. As last resort, a general reduction in the Trust's income tax and possible Capital Gains Tax (CGT) rate should be considered on a non-discriminatory basis.

Foreign tax proposal

The Davis Tax Committee has made the following proposals regarding taxing income received from foreign Trusts.

• Retain the deeming provisions of sections 7(8) and 25B(2A), insofar as they relate to non-resident Trusts;
  
• Tax all distributions from foreign Trusts as income/revenue; and
  
• Apply transfer-pricing rules relating to debt.

Rebuttal

We believe that the taxation of foreign actual distributions or 'deemed distributions' in the hands of a South African tax resident beneficiary as 'revenue' only is harsh. This approach ignores the accepted distinction between pure Trust capital, income and/or capital gains and it would be a mistake to mix the need for strong administration compliance requirements with that of legal policy.

Imposing an onerous administrative requirement on South African tax residents receiving foreign income and/or capital from foreign Trusts would make sense (instead of taxing the full amount of a distribution to them as 'income' regardless of its nature). SARS could simply request the recipient of such income to provide the applicable supporting documentation, be it in the form of detailed financial statements or tax certificates generated by the offshore trustees. Only at the point of non-compliance should a disregard for the nature of the distribution be considered. The onus of proof is already on the taxpayer.

Many larger offshore Trust houses are already located in highly regulated tax jurisdictions (of course, there are the exceptions) and have large and sophisticated accounting systems that can generate detailed financial statements and distribution certificates, if required. Again, we believe there is a case for strengthening the administration compliance on the South African resident recipient of an offshore distribution, as opposed to the implementation of 'harsh' taxation rules.

Inter-spouse proposal

On the matter inter-spouse bequests, the DTC has noted that there is no intellectual justification for the current exemption from donations tax in respect of property disposed of to a surviving spouse and the deduction from the value of an estate subject to estate duty in respect of property that accrues to the surviving spouse.

Because of this, and because no amount of refinement to the definition of a 'spouse' can cater for the diverse circumstances in South African families, the DTC has recommended that the principal of inter-spousal exemptions and roll-overs should either be withdrawn completely or be subject to a specified limit (as is the case with donations tax).

Rebuttal

We believe that scrapping or limiting the spousal exemption will create a financial constraint resulting from the need to pay estate duty before the death of the surviving spouse and this should be duly considered. For this to be implemented there needs to be a correlation with other taxes, such as the proposed changes to the donations tax spousal exemption.

It should be emphasised that the obligation to maintain one's surviving spouse is an entrenched principle in our law and is even codified in terms of the Maintenance of Surviving Spouses Act. It could be argued that the proposed amendments are contrary to this accepted principle of law in that they will limit the ability of the first spouse to die to maintain the surviving spouse.

We believe that the current spousal relief as well as the definition of 'spouse', as defined in the Income Tax Act, should be retained. However, we suggest that more regulatory requirements can be imposed on the taxpayer to provide evidence in support of a spousal or permanent relationship. This should be relatively easy to do without imposing too great an administrative burden on either SARS or the taxpayer. There must be consistency between all taxes concerning tax relief for the transfer of assets to a spouse.

The DTC may consider extending the inter-spousal exemptions and rollovers to include a wider class of family members, for instance minor children and/or elderly parents who were dependent on the deceased for maintenance. Such extension would cater for the reality of South African family structures, where the number of single parent families and extended families, who depend on each other, is high. These exemptions would ease any additional hardships on the family, which has to survive financially after the death. Even if the proposed primary abatement of R6 million is lowered to alleviate the loss in revenue from such extension to a wider class, the end result will be more fair in that wider society will benefit, and not only the more wealthy sector of society.