For all our clients who have investment portfolios structured in trusts - both trustees and beneficiaries - the release of the Davis Tax Committee (DTC) first interim report on 13 July 2015 put forward some concerning proposals.
However, I was extremely relieved to hear Professor Davis’ announcement that certain of the proposed amendments, as outlined in the interim report, would not be implemented.
THE CURRENT SITUATION
Section 25B together with section 7(1) of the Income Tax Act 58 of 1962, defines what is known as the conduit principle. This gives rise to income being received by, or accrued to, a vesting trust being taxed in the hands of the vested beneficiaries of the trust. However, income which is received by, or accrues to, a discretionary trust will be taxed in the hands of the trust, unless it is distributed before the trust’s financial year end, in which case income will be taxed in the hands of the beneficiaries. Furthermore, income so distributed or accruing to beneficiaries will retain its identity.
The retention of identity has important implications as beneficiaries, which are natural persons, will enjoy certain benefits regarding exclusion of certain income. For example:
In the 2016 financial year, natural persons under 65 years old will enjoy an interest exemption of R23800 and those 65 and over enjoy an interest exemption of R34500.
In the 2016 tax year 33.33% of any capital gain is taxed in the hands of the individual at the individual’s marginal rate after allowing for the annual exclusion (for the 2016 tax year the exclusion is R30,000). Contrast this with the taxation in the trust where 66.67% of the income is taxed at 41% with no annual exclusion for ordinary trusts.
THE RECOMMENDATION OF DTC
The interim release indicated that the provisions by which trust income is taxed in the hands of beneficiaries or a donor at lower marginal and inclusion rates, as opposed to the higher flat rate of tax in a trust currently 41%, should to be removed. This means that trust income would always be taxed at the higher rate applicable to trusts.
On 10 December 2015, Professor Davis assured the delegates of the South African Institute of Tax Practitioners that the conduit principle as outlined in section 8 as well as the deeming provision of section 7 would be maintained.
This is in stark contrast to the recommendations of the first interim report and it seems that the advantages enjoyed by trusts will continue.
So, at least for now, there is no need to be concerned that the important conduit principle will be attacked. Should you wish to understand this in any further detail - please don’t hesitate to contact our offices.