A new world
The world of offshore trusts is now more dynamic than ever. The benefit of trusts as effective tools for the preservation of assets for future generations has been commonly known and accepted for decades. Globally, the trust environment has changed significantly due to the introduction of the Common Reporting Standards and resulting Automatic Exchange of Information between various revenue authorities around the world. The identities of original funders and beneficial owners are no longer protected.
In addition, some jurisdictions view offshore trusts as transparent vehicles with potentially significant tax implications for the funder and beneficiaries of these vehicles. This increased transparency has made beneficiaries more aware of their rights against trustees and their entitlement to information relating to the management and administration of the trusts.
The increased transparency and the fact that information is more readily available will focus the attention of revenue authorities around the world on these structures. There is no reason why the South African Revenue Service should be an exception.
In terms our domestic law, an intricate range of tax provisions can apply to South African residents' relationship with offshore trusts. Foundations are also increasingly used which may have different tax consequences. The tax treatment of the funding of and distributions from offshore trusts has been the subject of debate for a number of years, culminating in amendments to the Income Tax Act, no. 58 of 1962 (the "Act") which were promulgated in 2018 (the "amendments").
Income and capital gains distributed from offshore trusts to South African resident beneficiaries are taxed in their hands when such distributions are made. The funding of these vehicles can also trigger a donations tax liability and resulting attribution rules can apply to include income and capital gains in the hands of the donors. Where a person connected to the trust sells assets to the trust on loan account, interest may be required to be charged.
The abovementioned amendments brought about an important change to structures where the assets are held by a company of which the trust is a major shareholder. Specifically, the payment of dividends from these companies and subsequent distributions to beneficiaries have changed from March 1, 2019.
Some highlights of the amendments relating to the participation exemption
Donors may be taxed on income received by or accrued to the offshore discretionary trust if this income was received by or accrued to the offshore trust by way of donation, settlement or other disposition made by the resident, provided that such income would have been included in the offshore trust's income had the trust been a resident. Interest-free loans or low-interest loans granted to the offshore trust are also covered by these provisions.
Previously, this rule could have excluded dividends distributed to a non-resident trust by a foreign company. Such a foreign dividend may not have constituted income had the trust been a resident, by virtue of the participation exemption in section 10B(2)(a) of the Act.
The participation exemption applies to the foreign dividends received by or accrued to a person that holds at least 10% of the total equity shares and voting rights in the foreign company declaring the dividend.
Previously, a capital distribution to a South African resident beneficiary by an offshore trust arising from a prior year's foreign dividends derived from a foreign company held by the trust, may have been exempt from South African tax if the trust had qualified for the participation exemption. Therefore, such a capital distribution may not have been taxable in South Africa in the hands of the beneficiary on the basis that no amount of income (as defined) would have arisen for the trust if it had been a resident.
In terms of the recent amendments, capital distributions by an offshore trust that are derived from such foreign dividends are now taxable in the hands of the South African resident beneficiary if certain conditions are met. However, South African residents would also still be able to benefit from the partial tax exemption applicable to foreign dividends.
Amendments to distributions of capital gains from offshore trusts
Paragraph 80(1) of the Eighth Schedule to the Act ("Eighth Schedule") provides that if a trust vested an asset in a resident beneficiary, the beneficiary would be subject to capital gains tax in respect of the related capital gain determined by the trust in respect of the disposal of the asset. Paragraph 80(2) of the Eighth Schedule provides that if a trust disposes of an asset and vests the resultant capital in a resident beneficiary in the same tax year, the beneficiary would be subject to capital gains tax in respect of the capital gain.
Previously, these provisions may not have been applicable to offshore trusts. Subsequent to the amendments, the resulting capital gain in respect of a disposal of an asset vested in a South African beneficiary of a trust is to be taken into account in determining the aggregate capital gain or loss of the resident beneficiary to whom the asset was disposed. This provision is now applicable to offshore trusts as well.
Some arrangements in respect of offshore trusts may need to be reported to the South African Revenue Service ("SARS"), unless they are excluded in terms of the Tax Administration Act no. 28 of 2011. Such reportable arrangements include contributions made by a resident to an offshore trust which exceed ZAR10-million, and where such resident has or acquires a beneficial interest in the offshore trust. These arrangements must be reported to SARS within 45 business days.
What to do?
Careful consideration should be given to current offshore structures. Firstly, resident taxpayers should be in touch with trustees and advisors acting in a fiduciary capacity to check what information is being exchanged with revenue authorities. It is likely that residents' participation in these structures in one way or another will be audited by SARS in years to come. Secondly, it is critical that disclosures now being made by offshore institutions in terms of the Common Reporting Standards correspond with disclosures made by individuals in their own returns and the necessary reporting is done. Taxpayers carry the onus of proof in any dispute with SARS and will therefore be required to explain any discrepancy.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.