Certain South African tax residents are beneficiaries of trusts that are constituted and operated off-shore. When the South African taxpayer receives a distribution or award from this foreign trust, there are a number of important matters to consider in order to correctly disclose this receipt in your local tax return. There are even circumstances where you do not actually receive an award from the foreign trust but when the income of that trust must be declared in your South African tax return. This article looks at the matters that need to be considered in both sets of circumstances in order to ensure that you are making full and proper disclosure in your South African Tax return.
Distributions received from foreign trusts
The most important question to ask initially of the trustees of the foreign trust is what the nature of the distribution is that you are receiving. In other words, is the amount you are receiving a distribution of a capital gain, interest, dividends or other income? Or is the amount distributed merely a distribution of the capital of the trust? Each of these distributions have different tax consequences. In terms of the Tax Administration Act, the onus of proving the nature of the amount received lies with the taxpayer. If you believe the amount you have received is exempt from tax, then you need to prove that to SARS. Ideally, you should receive a letter or some other notification from the trustees of the off-shore trust saying what the nature of the distribution was, in order to try to satisfy this burden of proof. Where a South African resident beneficiary receives a distribution from a foreign trust and they are unable to identify the constituent parts of that distribution, the full amount would be treated as taxable by SARS.
Let's look at the various distributions you could receive from a foreign trust.
Distribution of the capital of the trust - a distribution of the capital of the trust will not be taxable in South Africa as this is merely a return of the trust's capital and does not constitute a capital gain in terms of local tax legislation.
Distribution of foreign dividends - where the foreign trust derives dividends and awards that to a beneficiary, this dividend is taxable in South Africa. However the income tax payable thereon will generally not exceed 15%.
Distribution of a capital gain made by the foreign trust - at present there appears to be an unintended gap in the legislation as it relates to the distribution of a capital gain made by a foreign trust to a South African beneficiary. As the legislation now stands, if the foreign trust makes a capital gain in the same year that it distributes that gain to the beneficiary, that gain is not taxable in South Africa. However, if the trust made a gain in a previous year and only distributed in the following tax year, then this gain is taxable in the hands of the South African beneficiary. This anomaly appears to be a legislative oversight and it would be no surprise to see this corrected before long.
Distribution of other income - generally the principle is that the income distributed by the foreign trust retains its nature to the South African recipient. For example, if the trust earns interest income which it distributes, the taxpayer is deemed to have received foreign interest.
Could you be taxed on the income earned by a foreign trust if no distribution was made?
Generally, the answer to this question is no. If the income is retained in the trust, there are no tax consequences to the South African beneficiary. There is an exception to this rule for those persons who applied for amnesty under the 2003 amnesty legislation. Such persons are required to accept that the assets owned by the foreign trust are regarded as theirs for income tax and capital gains tax purposes, and as and when income is derived by the foreign trust, that income will be taxed in the hands of the amnesty applicant.
Finally, a look into the future. The Davis Tax Commission has recommended that in future all distributions of foreign trusts be taxed in full as normal income. This proposal is justified by the Committee on the basis of seeking to discourage the creation of offshore trusts because of the deferral of the tax that a beneficiary obtains through the use of such trusts. However, this is not yet law and so in the interim, the old principles and rules set out above will continue to apply.