Provisional Tax Status for Discretionary Trusts Clarified

by | Oct 26, 2023 | Advisory Services | 0 comments

In recent times, our organization has been inundated with inquiries pertaining to the tax return submission deadlines for trusts. This surge in queries arises from the South African Revenue Services’ (SARS) communication on their website over the past two years, suggesting that most trusts are considered non-provisional taxpayers. Consequently, they are mandated to submit their annual tax returns by 23rd October 2023. In contrast, the deadline for annual tax return submissions for provisional taxpayers is set for 23rd January 2024.

SARS has not been particularly forthcoming in offering clarity regarding the annual tax return submission deadlines for trusts. In a media release, posted on their website, they announced that provisional taxpayers and trusts should submit their tax returns between 7th July 2023 and 23rd January 2024.

Our organization is currently engaged in a series of discussions and exchanges with the South African Revenue Service (SARS) concerning the tax status of trusts, particularly their classification as provisional taxpayers. Over the past three months, we have initiated numerous dialogues and submissions to address this crucial matter.

The basis for SARS classifying trusts as non-provisional taxpayers revolves around the interpretation of Section 25B of the Income Tax Act No. 58, as amended (ITA). According to this provision, the conduit principle is invoked when distributions are made under Section 25B. Essentially, this principle posits that the trust does not directly receive the income; rather, the income is distributed to the beneficiaries and then taxed in the hands of the beneficiary.

The definition of a provisional taxpayer, as specified in paragraph (1) of the Fourth Schedule, encompasses the following categories:

  1. Individuals (excluding companies) who receive remuneration from an entity not registered for employees’ tax as an employer.
  2. Any person (as defined in Section 1 of the ITA) (excluding companies), who receive income that does not constitute remuneration or allowances such as travel, subsistence, or public office allowances.
  3. Companies.
  4. Persons designated by the Commissioner.

Furthermore, the term “person” in the context of this definition includes an insolvent estate, the estate of a deceased person, any trust, and any portfolio of a collective investment scheme.

The term “income” refers to the remaining amount of income for a given year or assessment period after exempt income has been deducted from gross income, meaning income such as dividend income is not considered income for provisional tax purposes.

In many cases, trusts do not receive income (gross income minus exempt income) due to the “conduit principle,” and they do not fulfil the criteria for provisional taxpayer status. In other cases, where a trust exclusively receives dividend income, it is regarded as a non-provisional taxpayer, as the prerequisite for income is not met.

It is essential to note that Section 25B is not currently included within the definition of a provisional taxpayer. As it stands, there is no clear link between Section 25B and the provisional taxpayer definition. We are of the opinion that SARS should provide clarity within the provisional taxpayer definition to specifically include or exclude trusts.

Unless clarity is received, we anticipate the following obstacles:

• If SARS maintains its current position, it can be argued that trustees, particularly in the case of discretionary trusts, retain the discretion to make distribution decisions at year-end. This implies that the trust is a provisional taxpayer when submitting its first provisional tax return and may no longer be considered as such when submitting the second provisional tax return. Consequently, the trust would be a provisional taxpayer for 11 months of the year and a non-provisional taxpayer for the remaining month.

• This classification may vary on an annual basis for discretionary trusts, dependant on whether they distribute all the income during the tax year or whether they retain all the income in the trust for a specific year.

• Furthermore, when SARS designates a trust as a provisional taxpayer on the ITA34 and the trust’s statement of account, it remains in this status until SARS explicitly informs the trust that it is no longer classified as such. This aligns with point 4 in the definition mentioned above. We have observed this designation (provisional taxpayer) on past assessments where all income has been distributed.  This practice from SARS does not align with their non-provisional taxpayer view.

We are also seeking clarity from SARS on two additional issues:

  1. How will the tax compliance status apply to trusts that have submitted a first provisional tax return but not a second? Will the tax compliance status be deemed non-compliant due to SARS’s expectation of receiving the second provisional tax return, even if it is ultimately not required?
  2. How will penalties for late submission of annual returns be assessed? If a trust was a provisional taxpayer for most of the year but was later not required to submit a second provisional tax return due to the distribution of all taxable income at the end of February, how will penalties for late submission of annual tax returns be determined, considering the change in submission deadlines from January to October?

We expect that these clarifications will offer greater certainty and consistency regarding the provisional tax status of trusts. Currently, however, we find ourselves at odds with SARS, which, we believe, is not aligned with the current legislation in the Income Tax Act.

For further clarifications or inquiries, please reach out to our Consulting Team, comprising Michelle Tickner and Jacori Uys in our Accounting, Tax and Corporate Compliance Team, accessible via the provided contact details.

Authors: Michelle Tickner and Jacori Uys