If you are considering investing offshore via a foreign trust or have already done so, it is important to consider the amendments as introduced by the 2018 Taxation Laws Amendment Bill published on 25 October 2018.
In 2017, the Income Tax Act was amended to prevent companies from evading the provisions dealing with controlled foreign companies (“CFCs”), by investing in foreign companies via foreign trusts. This was achieved by expanding the definition of a CFC to include any foreign company where IFRS10 requires the financial results of such foreign company to be included in the consolidated financial statements of a South African resident company. As a result of these amendments, the CFC provisions could be applied to foreign companies, even where a South African resident company held shares in the foreign company via a foreign trust.
However, the 2017 amendments did not address interests held in foreign companies via a foreign trust by individuals. While amendments were proposed in this regard, the proposed amendments were withdrawn after concerns were raised that the proposed amendments were too complex and that their scope was too wide.
The taxation of trusts and beneficiaries
In general, where no beneficiary has a vested right to the income of the trust, such income will be taxed in the hands of the trust. The trust will be entitled to any relevant income tax exemptions provided for by the Income Tax Act. For example, where a trust receives a foreign dividend, the trust will be entitled to any relevant income tax exemptions provided for by section 10B of the Income Tax Act.
Once a trust beneficiary acquires a vested right to the income, for example when the trust distributes the amount to the beneficiary, such income will be taxable in the hands of the beneficiary, unless the amount was already taxed in the hands of the trust or where the amount is required to be attributed to a resident donor under the provisions of section 7 of the Income Tax Act.
The income that is distributed by the trust to the beneficiary retains its nature in the hands of the beneficiary. This is the so-called “conduit pipe principle”. Therefore, the trust beneficiary will also be entitled to any relevant income tax exemptions. Therefore, if the trust distributed foreign dividends to a trust beneficiary, the trust beneficiary will also be entitled to any relevant foreign dividend exemptions provided for by section 10B of the Income Tax Act.
One of the foreign dividend exemptions provided for by section 10B, is generally referred to as the “participation exemption”. The participation exemption fully exempts foreign dividends from normal income tax, where these dividends arose from a foreign equity shareholding of at least 10%. A similar exemption is contained in paragraph 64B of the Eighth Schedule to the Income Tax Act, which allows a person to disregard any capital gain or loss determined in respect of the disposal of any equity share in a foreign company, provided that the person held an interest of at least 10% in the foreign company.
In the 2018 Taxation Laws Amendment Bill, the Legislator has revisited its 2017 proposals to address indirect interests in foreign companies held by South African resident individuals via a foreign trust. In simple terms, the impact of the amendments would be to disregard the participation exemption where:
- A foreign dividend is received by a foreign trust (with participation or voting rights in a foreign company of more than 50%), and such amount is only distributed in a subsequent year to a South African beneficiary of the foreign trust.
- Capital gains are realised with respect to the disposal of shares in a foreign company and such gains are only vested in a subsequent year in a South African beneficiary of the foreign trust.
Similar amendments were also effected to the donor attribution rules. The donor attribution rules are triggered where income or gains are attributable to a donation made by a South African resident to a trust. In terms of the donor attribution rules, any amount received by / accrued to a trust or distributed to a trust beneficiary is attributed to such resident donor, to the extent to which the amount relates to any donation made by such donor. In other words, the income is taxed in the hands of the resident donor, and not in the hands of the trust or trust beneficiary.
These amendments are proposed to become effective for receipts / accruals on/after 1 March 2019. It would therefore be prudent to keep these amendments in mind if you are busy with tax restructuring or tax planning which incorporates offshore investments to be held by foreign trusts.