For generations, the use of trusts in estate planning has been a popular method to safeguard and manage the various costs of transferring assets between generations, both for present and future heirs. Trust law and the taxation of trusts is therefore a well-known concept in the South African sphere.
An established principle in relation to the taxation of trusts is the “conduit principle” in terms whereof trust income or capital that has been vested in beneficiaries is not taxed in the hands of the trust, but rather in the hands of the beneficiaries. This principle allows income received by a trust and immediately passed on to a beneficiary in the same year in which it was received, to be regarded as income which accrued to the beneficiary and not to the trust.
Let’s consider a typical scenario of a trust owning shares on which dividends have been declared. The distribution of those dividends to the beneficiary in the same year, is regarded as income which accrues to the beneficiary and not the trust.
What happens if the beneficiary of the South African trust is a NON-RESIDENT for tax purposes?
If there is an Agreement for the Avoidance of Double Taxation (DTA) between South Africa and another country (of which the beneficiary could be a tax resident), and the beneficiary is taxed again in their country of residence, the beneficiary may be entitled to access the DTA to obtain relief with regards to certain taxes. It is important to note that DTA’s provide relief in instances where the same person is taxed twice on the same income.
The distribution of a dividend within the year of assessment to a NON-resident beneficiary, should allow the beneficiary access to DTA relief which generally limits the percentage Dividend Withholding Tax (DWT) payable, since the DWT was withheld on their behalf and not on behalf of the trust (a different taxpayer). However does this practically happen without an expensive fight with SARS?
We contend in LAW, non-residents can access the DTA relief with regards to the application of DWT. The DTA will either limit the amount of DWT that can be withheld or provide a tax credit or a deduction in the country of residence if that tax country’s tax authority levies additional taxes on the foreign dividends.
However, in practice, this is not applied.
Franked dividend refers to the dividend on which taxes have already been paid by the company. In other words, the investors and the dividend receive a tax credit equal to the amount of taxes withheld by the issuing company and paid on behalf of the recipient. A franked dividend is paid with a tax credit attached and is designed to eliminate the issue of double taxation of dividends for investors, since DWT is a final tax which the company issuing the dividend pays on behalf of the investor. Because DWT has been withheld by the company, and DWT is a final tax, no further tax should be paid by the shareholder.
When frank dividends are declared, the secretary of the company declaring the dividend could not possibly be expected to know that one of its investors, being the Trust, will distribute the dividends to its beneficiaries, let alone to WHO (a resident or non-resident).
The dividend could be retained in the trust, distributed to a resident beneficiary, distributed to a non-resident beneficiary or even get taxed in the hands of the donor of the asset in terms of the attribution rules in Section 7 of the Income Tax Act.
The problem now arises that the non-resident beneficiary who receives the dividend in the same year of assessment does not get access to the DTA’s reduced DWT percentage purely due to the fact that the dividend certificate only stated that it has been declared to the trust and not to the specific beneficiary. One of course also must consider how this trust construct will be viewed by the tax authority of the beneficiary’s country of residence.
There are 3 options available:
- Make the secretary of the company declaring the dividend aware of the situation and the trustees intention of distributing the dividend in the same Year of Assessment to the non-resident beneficiary. This has to be done before the declaration of the dividend in order to get the certificate addressed to the appropriate beneficiary.
- Take on an expensive fight with SARS and then try to get the company secretary to re-issue the dividend certificate.
- Engage in a restructuring of the trust by adding an underlying company and issuing shares to the non-resident beneficiaries in this company. This will provide certainty to the non-resident person by enabling them to directly receive a dividend declared from a company instead of a trust distribution. This should enable them to get access to relief under the DTA where applicable.
Are you unsure how to address this problem of non-resident beneficiaries receiving dividends from a south African trust? Sentinel International’s team of experts would love to review your situation and do the necessary tax planning to avoid this issue.
Anne du Plessis, Senior Tax Specialist CA (SA) MCOM (Tax)