In South Africa, a trust is a practical, legal way to manage assets for the benefit of others. Offering unique tax benefits if utilised correctly, navigating the complexities of trusts in South Africa requires careful consideration of all of the tax implications involved for expats. For example, while it’s tempting to distribute all trust income and capital gains to beneficiaries to avoid high trust tax rates, this strategy can actually trigger unintended tax consequences. Here’s what you need to know about the taxation of trusts in South Africa and trust distributions to beneficiaries outside of South Africa to ensure you stay on the right side of the law.

Section 7C donations tax and estate duty

If you were wondering how trusts are taxed in South Africa, one major tax consideration is Section 7C of the Income Tax Act. This provision targets attempts to postpone or avoid estate duty by treating certain loans with low interest rates as “deemed donations.” Donations tax is then applied to the difference between the actual interest charged and the official rate.

The interplay between donations tax and estate duty gets tricky. Both taxes are levied on gratuitous transfers (during life and at death) at the same rates. However, there’s no apportionment between the two tax brackets. This means exceeding the R30 million threshold for cumulative donations pushes the entire estate into the higher 25% tax bracket.

Section 7C effectively closes a loophole where assets were transferred to trusts on interest-free loans, effectively using trusts to avoid taxes as this arrangement prevented estate duty on asset growth within the trust. Now, individuals pay taxes during their lifetime to compensate for this “loss” to the revenue authority, assuming a growth rate on trust assets.

Read more:

• Five Important Questions on Donations Tax: what expats need to know.
• Section 7C of the Income Tax Act: Loans to trust at preferential rates.

Taxation of trusts in South Africa: distributions and attribution rules

Trusts benefit from the “conduit principle,” allowing income and capital gains to be taxed at the beneficiary’s marginal tax rate, potentially lower than the trust’s rate. Income and capital gain splitting can further reduce the effective tax rate by distributing these gains to multiple beneficiaries in lower tax brackets.

However, this focus on minimising tax for the current year can lead to overlooking the “attribution rules” of the Income Tax Act. These rules dictate that some or all trust income and capital gains may be attributed to the donor, who then becomes responsible for the tax burden.

With the South African Revenue Service (SARS) increasing scrutiny of attribution rules, blindly distributing income to beneficiaries to save tax can result in penalties and interest. Especially considering the challenges of transferring assets into a trust due to Section 7C, “bleeding” growth out of a trust for short-term tax savings might not be the smartest move.

Taxation of trusts in South Africa: double taxation risk

The introduction of Section 7C to act as a prepayment of estate duty creates a potential double taxation scenario. There’s no mechanism to claim rebates on Section 7C donations tax previously paid against the final estate duty calculation upon the beneficiary’s death.

Take a more strategic approach to trust distributions to beneficiaries in (and out of) South Africa.

Distributing trust assets requires careful planning to understand the full tax implications:

• Consideration should be given to each beneficiary’s estate to avoid exceeding the R30 million threshold and triggering additional taxes.
• Focusing solely on minimising the current year’s trust tax through distributions might lead to unintended consequences down the line.
• Sometimes, using available funds to repay a loan that attracts Section 7C donations tax might be a better strategy. Unlike estate duty, this tax applies regardless of whether the asset is bequeathed to a family member.

By taking a comprehensive approach that considers both short-term and long-term tax implications, trustees can ensure they are maximising the benefits of a trust structure.

Read more:

• Protecting your assets and beneficiaries with a trust in South Africa: advice for expats.
• ​​Inter vivos trusts in South Africa: how to transfer money to offshore beneficiaries.

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