The Thistle Trust is a beneficiary of various vesting trusts (“Tier 1 Trusts”) that conduct the business of property owners and developers. The Tier 1 Trusts disposed of certain capital assets and distributed the capital gains in the same tax period to its beneficiaries, which included the Thistle Trust. The Thistle Trust, in turn, during the same tax period distributed the amounts it received to its beneficiaries. The Thistle Trust, applying the conduit principle, treated the amounts it received as taxable in the hands of its beneficiaries.
SARS raised additional assessments taxing the distributions in the hands of the Thistle Trust and not its beneficiaries. The tax court set aside these assessments finding that the amounts distributed fell within section 25B and Paragraph 80(2) of the 8th Schedule of the Income Tax Act. SARS thereafter appealed to the Supreme Court of Appeal (SCA) who were tasked with determining whether the capital gains were taxable in the hands of the Thistle Trust or its beneficiaries.
The SCA held that the Tax Court was wrong in applying section 25B as that provision applied only to the taxation of income that accrues to a trust or its beneficiaries. Paragraph 80(2) was the correct provision to apply to the taxation of capital gains distributions from trusts.
The Tier 1 Trusts vested the capital gains in the Thistle Trust, which accordingly held a vested right to the capital gains. The distribution of the gains to the Thistle Trust resulted in it receiving the gains as of right. However, the SCA pointed out that the Thistle Trust did not dispose of any capital asset nor determine a capital gain that was distributed to its beneficiaries. Paragraph 80 requires a trust to ‘determine a capital gain’ before the conduit principle can apply. Instead, the Thistle Trust distributed monies that had vested in it as of right. Therefore, the SCA held that the capital gains were taxable in the Thistle Trust and not its beneficiaries.
An advantage of distributing capital gains to natural persons who are trust beneficiaries is that the gains will be taxed at a lower effective rate (i.e., 0 -18%) than if they were taxed in the trust itself (i.e., 36%). Trusts that have trusts as beneficiaries must be careful not to fall into the same tax trap as the Thistle Trust. Once a trust disposes of a capital asset and distributes the capital gain to another trust that capital gain will become taxable in that trust.
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