The Taxation Laws Amendment Act 23 of 2020 contains amendments to section 25B and paragraph 80 of the Eighth Schedule, which on the surface may appear inconsequential but do have important tax implications. These amendments came into operation on the date of promulgation, namely 20 January 2021
AMENDMENTS HAVING CGT CONSEQUENCES (SECTION 25B(1), PARAGRAPHS 80(2) AND (2A))
The heading of section 25B has been changed from ‘Income of trusts and beneficiaries’ to ‘Taxation of trusts and beneficiaries of trusts’. The new heading is more descriptive because section 25B does not deal exclusively with income but also with deductions.
Section 25B(1) has been amended by the insertion of the words ‘(other than an amount of a capital nature which is not included in gross income …)’.
The reason for excluding amounts of a capital nature is best explained with an example.
Example 1 – Attribution of capital gain and multiple discretionary trusts (paragraph 80(2))
Trust 1 disposes of an asset to a third party and realises a capital gain of R100, which it vests in Trust 2 in the same year of assessment. Trust 2 then on-distributes an amount equal to this capital gain to Jack and Jill in equal shares. All parties are residents.
Under paragraph 80(2) the trust that disposed of the asset must disregard the capital gain and its beneficiary in whom the gain was vested must take it into account. No provision is made for attribution of the capital gain beyond the beneficiary of the trust that disposed of the asset.
The capital gain of R100 must therefore be brought to account by Trust 2 and not by Jack and Jill because they are not beneficiaries of Trust 1. The result is that Trust 2 will pay CGT of R36 on the capital gain (R100 × 80% inclusion rate) × 45% (flat rate of tax), while had Jack and Jill been taxed on their respective shares of the capital gain, they would have each paid a maximum of R9 (R50 × 40% inclusion rate) × 45% (maximum marginal rate).
Given that the tax burden under paragraph 80(2) is at least double what it would have been had Jack and Jill been taxed on the capital gain, tax planners have for years sought ways in which to get around paragraph 80.
One argument that has been advanced is that the capital gain can flow to Jack and Jill under section 25B.1 Unlike paragraph 80, section 25B(1) allows income to flow through multiple trusts in the same year of assessment regardless of whether the trusts and their beneficiaries are residents.
The exclusion of amounts of a capital nature puts paid to the argument that proceeds from the disposal of a capital asset fall within section 25B(1) and can accrue to a resident or non-resident beneficiary by distribution through multiple discretionary trusts.
Paragraphs 80(2) and (2A)
Before dealing with the amendments to paragraph 80, it is necessary to distinguish between a capital gain and an amount that would have been a capital gain had a trust been a resident. Under paragraph 2(1)(a) the Eighth Schedule applies to any asset of a resident. By contrast, under paragraph 2(1)(b) non-residents are required to account for CGT only on
Immovable property situated in South Africa or any interest or right of whatever nature to or in such property including rights relating to mineral deposits, sources and other natural resources, or
Any asset effectively connected with a permanent establishment in South Africa
Also included under paragraph 2(1)(b) by virtue of paragraph 2(2) are equity shares in a company, interests in other entities, and vesting trusts holding rights and interests in immovable property in South Africa provided various requirements are met. Paragraph 2(2) was also amended to clarify that the various entities have to hold immovable property in South Africa and not just any immovable property. Simultaneously, the scope of paragraph 2(2) has been extended to include other rights and interests in such property.
After its amendment, paragraph 80(2) now deals with capital gains derived by resident or non-resident trusts. For resident trusts it deals with any asset and for non-resident trusts it deals only with the assets referred to in paragraph 2(1)(b). It has, with slight modification, been restored to its pre-2019 position. In other words, it will give the same result as described in example 1.
Its application to non-resident trusts is illustrated in this example:
Example 2 – Non-resident trust deriving capital gain from immovable property (old and new paragraph 80(2))
Non-resident discretionary Trust 1 has two beneficiaries, non-resident discretionary Trust 2 and John, a resident. Trust 1 sold an office building in Johannesburg and vested 50% of the resulting capital gain in Trust 2 and 50% in John.
The portion of the capital gain vested in Trust 2 must be accounted for by Trust 1 because no attribution is possible to a non-resident under paragraph 80(2). Trust 1 must disregard the other half of the capital gain and John must account for it.
A new paragraph 80(2A) has been inserted to deal with a non-resident trust deriving an amount which would have constituted a capital gain had it been a resident. In other words, it will apply to any asset of a non-resident trust other than the assets dealt with in paragraph 80(2). It provides as follows:
(2A) (a) Subject to paragraphs 64E, 68, 69 and 71, this subparagraph applies where −
(i) a beneficiary who is a resident (other than any person contemplated in paragraph 62(a) to (e)) derives an amount through vesting during a year of assessment from a trust that is not a resident; and
(ii) that amount was derived directly or indirectly from that trust or another trust which is not a resident in respect of the disposal of an asset during the same year of assessment and that amount would have constituted a capital gain had the trust that disposed of the asset been a resident.
(b) Where item (a) applies, the amount derived by the beneficiary must be taken into account as a capital gain for the purpose of calculating that beneficiary’s aggregate capital gain or aggregate capital loss for that year of assessment.
Unlike paragraph 80(2), which allows attribution only once to the beneficiary of the discretionary trust that disposed of the asset, paragraph 80(2A) applies the conduit principle in a manner similar to section 25B(1). As a result, an amount that would have been a capital gain had a non-resident trust been a resident can flow through multiple non-resident trusts before reaching a resident beneficiary.
Example 3 – Capital gain flowing through multiple non-resident discretionary trusts in the same year of assessment (paragraph 80(2A))
On 1 March 2021, non-resident discretionary Trust 1 disposed of listed shares to a third party and realised a capital gain which it immediately vested in non-resident discretionary Trust 2 which immediately vested the same amount in Jane, a resident.
The gain realised by Trust 1 on disposal of the listed shares would have constituted a capital gain had Trust 1 been a resident. The same amount was derived indirectly by Jane from the capital gain realised by Trust 1 and must accordingly be accounted for as a capital gain by her in the 2022 year of assessment.
As with the old paragraph 80(2), neither the new paragraph 80(2) nor (2A) permits the attribution of capital losses. An amount that would have been a capital loss had a trust been a resident falls outside the Eighth Schedule under paragraph 2(1)(b).
Amendments affecting terminating trusts holding rights to living annuities
This refers to section 25B(1), paragraph (eA) of the definition of ‘living annuity’ in section 1, paragraph 3A of the Second Schedule.
Section 25B(1) has been amended by the insertion of the words ‘(other than … an amount contemplated in paragraph 3B of the Second Schedule)’.
Paragraph 3B has been added to the Second Schedule. The definition of ‘living annuity’ in section 1(1) has been amended by the insertion of a new paragraph (eA). The amendments to section 25B(1) and the insertion of paragraph 3B come into operation on 20 January 2021. Inconsistently, however, the insertion of paragraph (eA) comes into operation on 1 March 2021.
By way of background: an annuitant can nominate a trust as a beneficiary and upon his or her death, the trust will acquire a right to the living annuity. Paragraph (eA) of the definition of ‘living annuity’ provides that in anticipation of the termination of a trust, the value of the assets which funded the annuity must be paid to the trust as a lump sum pursuant to that termination. Paragraph 3B of the Second Schedule then provides that such a lump sum benefit is deemed to have accrued to that trust immediately prior to the date of its termination. The effect of excluding such a lump sum benefit from attribution to beneficiaries under section 25B(1) is to make it taxable in the trust at the rate according to the tax table applicable to retirement fund lump sum benefits.
1 SARS addresses this argument in its Comprehensive Guide to Capital Gains Tax (Issue 9) in 14.11.1 (‘Non-applicability of s 25B to capital gains and losses’).