Changes in Tax Residency: Impact on Trusts – A South African Perspective

by | May 31, 2024 | Advisory Services | 0 comments

The cessation of tax residency by trustees and beneficiaries of South African trusts introduces a multitude of intricate challenges that require meticulous consideration and strategic planning. This article will aim to assist in identifying complexities and potential punitive tax implications associated with these changes, emphasizing the importance of understanding and addressing the multifaceted issues at play.

Identifying the Complexity

Trustees often encounter costly challenges due to inadequate recognition of issues arising from non-resident trustees and beneficiaries across multiple jurisdictions. Let’s look at some key questions to assist trustees in identifying the complexity:

  1. Implications of Foreign Trustees: What are the compliance requirements for having foreign trustees?
  2. Trust Deed Provisions: Does the trust deed/governing document permit non-resident trustees and beneficiaries?
  3. Distributions to Non-Residents: What are the tax and legal implications of making distributions to non-resident beneficiaries?
  4. Exchange Control Implications: Will distributing to non-residents involve exchange control complications?
  5. Tax Implications for the Trust: Will the trust face punitive tax consequences?

Foreign Trustees

According to Section 5 of the Trust Property Control Act, trustees must notify the Master of the High Court of any change in their address within 14 days via registered post. Section 8 of the Act allows for the appointment of foreign trustees, with the Master of the High Court potentially requiring security before authorizing their roles.

Redomiciling the Trust

A trust typically requires at least one independent trustee and several other trustees for its management. When the majority of trustees reside outside South Africa, the trust’s effective management shifts to the new jurisdiction. Redomiciling the trust necessitates understanding the support for trust structures in the new jurisdiction, along with its reporting and compliance requirements, and assessing the tax implications.

Steps to Redomicile a Trust:

  1. Deregister the trust with the Master of the High Court.
  2. Settle any outstanding tax liabilities and deregister with the South African Revenue Service (SARS) to exit the South African tax net.
  3. Execute a Deed of Retirement and Appointment (DORA).

Locked into Trust Structures

Discretionary trusts offer flexibility in planning, while testamentary trusts, trusts established by court order, and special trusts have constrained powers and planning options when there is a change in residency. Testamentary trusts are governed by the founder’s last will and testament, and trusts established by court order are bound by judicial decisions. Modifications to these trusts require High Court applications, which are costly, time-consuming, and not guaranteed to be approved. If the court denies the amendments, assets may become undistributable, leading to adverse tax consequences for beneficiaries or punitive tax implications for the trust.

Removing a beneficiary from a trust can be complex. The trust deed, which governs the trust, must be reviewed to determine its provisions regarding foreign trustees and beneficiaries. Often, trust deeds prohibit trustees from changing beneficiaries, necessitating a High Court application for any amendments.

Distributions to Beneficiaries in Different Jurisdictions

Distributions to non-resident beneficiaries often proceed despite potential punitive implications. Jurisdictions vary in their recognition of trust structures and their taxation of distributions, a careful analysis of how distributions would be treated is required. Some jurisdictions provide clear guidelines on taxing distributions, while others do not recognize trusts as separate legal entities, leading to uncertainty on how distributions are to be treated.

The conduit principle has made trusts effective tools for wealth preservation and protection. However, when a beneficiary becomes a non-resident, trustees can no longer vest income or gains to the beneficiary, making the trust liable for the tax. This increases the trust’s tax liability significantly, with an income tax rate of 45% and an effective capital gains tax rate of 36%, compared to 18% for individuals. Trusts do not benefit from interest or capital gain exemptions.

Exchange Control Implications

Beneficiaries who have recorded their emigration with the South African Reserve Bank (old process) or ceased their tax residency with SARS (new process) are considered non-residents. The source of the distribution, whether capital or income, determines the process. Non-resident beneficiaries must apply for Approval of International Transfer for amounts below ten million. For amounts exceeding ten million, they must also obtain approval from the South African Reserve Bank to remit foreign exchange offshore using the foreign capital allowance. Exchange control regulations frequently change, so consulting an authorized dealer is advisable.

Assisting trustees to navigate complexities

Firstly, the implications of having foreign trustees cannot be overstated. Compliance with the Trust Property Control Act, particularly sections 5 and 8, is essential to ensure the legality and smooth operation of the trust. Trustees must promptly inform the Master of the High Court of any changes in their address and be prepared for potential security requirements for foreign trustees. Failure to comply with these regulations can lead to significant legal and financial repercussions.

Redomiciling the trust involves a series of procedural and compliance steps that must be carefully navigated. The trust’s management must align with the jurisdictional requirements of the new location, which includes deregistration with South African authorities and settling all outstanding tax liabilities. The execution of a Deed of Retirement and Appointment (DORA) formalizes the domiciliation process, ensuring the trust’s continued operation in the new jurisdiction.

The rigidity of certain trust structures, such as testamentary trusts and trusts established by court order, presents additional hurdles. These trusts are bound by specific governing documents or court orders, and any modifications necessitate High Court applications. The time-consuming and costly nature of these applications, coupled with the uncertainty of court approval, underscores the need for strategic foresight and legal consultation when considering changes in residency.

Distributions to non-resident beneficiaries add another layer of complexity. Jurisdictional variations in the recognition and taxation of trust structures require trustees to have a deep understanding of international tax laws and regulations. The conduit principle, while beneficial for wealth preservation, imposes significant tax liabilities on the trust when beneficiaries are non-residents. The trust’s tax burden can escalate, with income tax rates reaching 45% and capital gains tax rates at 36%, compared to significantly lower rates for individuals. This disparity necessitates careful planning to mitigate the financial impact on the trust and its beneficiaries.

Exchange control implications further complicate distributions to non-resident beneficiaries. Compliance with South African Reserve Bank regulations is critical, especially for beneficiaries who have formally recorded their emigration or ceased their tax residency. The process for obtaining Approval of International Transfer and navigating the foreign capital allowance requirements necessitates ongoing consultation with authorized dealers to stay abreast of regulatory changes.

In conclusion, the cessation of tax residency by trustees and beneficiaries of South African trusts demands a comprehensive and proactive approach. Trustees must act with due diligence and care, as mandated by the Master of the High Court, to manage these complexities effectively. Seeking professional advice from tax experts, legal advisors, and authorized dealers is indispensable to navigate the intricacies of international trust management and ensure the best interests of the beneficiaries are upheld. By thoroughly understanding and addressing the potential pitfalls and regulatory requirements, trustees can safeguard the trust’s assets and mitigate adverse tax implications, ensuring the continued efficacy and integrity of the trust structure in a globalized context.

Written by: Chanel Schoeman, Fiduciary Specialist.

Sentinel International Advisory Services