The attribution rules in the Income Tax Act were introduced decades ago, mainly to prevent tax avoidance by means of a donation, settlement, or other disposition in various types of schemes. However, the policing and application of the rules have largely been neglected or ignored.
The South African Revenue Service (Sars) has signalled that it will be paying closer attention to the application of these rules in trust structures, warns Phia van der Spuy, founder of Trusteeze.
It is compulsory for all trusts to be registered with Sars and to submit annual tax returns, whether they are dormant, passive, or trading. From next year, it is compulsory for all trusts to issue tax certificates (IT3(t)) for distributions made to beneficiaries by the end of May each year. This is like the reporting requirements for financial institutions, medical schemes, and retirement funds.
The IT3(t) for trusts is akin to the IRP5 certificate for employers.
The requirements form part of Sars’s vision to create a smart and modern tax agency by expanding its base of third-party data suppliers. The aim is to obtain all information relating to an individual, for the introduction of a complete auto-assessment regime.
Trust tax savings
The new reporting requirement for trustees highlights the need for proper accounting systems and for adherence to all the tax rules, Van der Spuy says.
Trusts used to be taxed at a lower rate than individuals. It was beneficial for people to transfer their assets into trusts to “save tax” by being taxed on the income generated in the trust.
However, Sars quickly picked up on the practice, hence the introduction of attribution rules in the Income Tax Act.
In short, the attribution rules state that where a funder transfers assets into a trust through a low-interest or an interest-free loan, a portion of the income (the benefit of the interest saved by the trust) should be attributed to the income of the funder.
When an asset is donated to the trust, the full income earned on the donation must be attributed to the donor. Since the introduction of capital gains tax, similar rules apply to capital gains in a trust. The calculations are complicated and tricky to monitor.
Ignorance of rules
Van der Spuy says a major concern is that many accountants were either unaware of the attribution rules or ignored them. Many trusts may have been non-compliant for years, which leaves them exposed to penalties and fines.
Nina Keyser, partner at law firm Webber Wentzel, provides an example of a parent donating assets worth R1 million to a family trust. The trustees distribute all the income generated by the assets to the minor children and the non-working spouse, who are not liable for tax.
However, the trustees or the appointed tax practitioner must attribute the income back to the parent, who must declare it and pay tax at his tax rate.
Sars has increased ways to check and cross-check information. Donors or funders must declare trust income and capital gains attributed to them. That was the warning Sars gave in a recent communication to professionals.
If they have not declared the income and the intention was to avoid paying tax, they expose themselves to audits going back way beyond the prescription period of three years, Keyser says.
If the taxpayer’s declarations in the annual return do not match the declaration made by the trust in the IT3(t), they will be exposed to audits and penalties and interest on unpaid taxes going back many years.
Last resort
“Trusts are unique animals. They are the taxpayer of last resort,” Van der Spuy says. The attribution rule is the number-one rule, and it is compulsory.
The benefits accrued or deemed to have accrued to the donor or funder in terms of donations or interest-free or soft loans (lower than market-related interest rates) must be calculated and attributed to the donor or funder.
Trustees can apply the conduit principle to distribute any remaining income and capital gains to beneficiaries. If income or capital gains remain in the trust, they must be declared in the trust’s income tax return.
If the rules are applied correctly, it is beneficial for the trust, says Van der Spuy, because trusts pay tax at the highest rate from the first rand of income or capital gains realised.
She advises trustees who have not applied the rules or whose trust management has not been compliant to consider a voluntary disclosure application.
The trustee or representative taxpayer can be held personally liable if he “alienates, charges, or disposes of amounts in respect of which the tax is chargeable”, says Keyser.
Trustees or appointed tax practitioners who have not submitted trust tax returns, whether the trust is dormant or active, or who have provided false information, face criminal charges, and can be fined or sent to prison for up to two years, she says.
Estate duty
Accountants or tax practitioners may think they are saving tax for their clients when they distribute income or capital gains generated in a trust to beneficiaries (who have a lower tax rate than trusts), Van der Spuy says.
In a perverse way, Sars may be benefiting from people diluting trusts, where assets, income, or capital gains end up in the estate of the beneficiary, where it is subject to 20% estate duty on the first R30m and 25% on estates above R30m.
Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law and regulatory issues.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article does not constitute financial planning, legal or tax advice that is appropriate to every individual’s needs and circumstances.
