Trusteeshavemadedistributionstosavetax–nowwhat?

MANY boards of trustees have made distributions (often on paper only) to beneficiaries for the financial year ending February 28 in order to pay less tax on trust income and capital gains. But it should not have stopped there: beneficiaries had to be informed so they could include the distributions in their respective tax returns, the trustees need to manage distributions separately for the beneficiaries and they need to keep proper records.

Do beneficiaries have a right to the distributed amount?

If the trustees decide to utilise the conduit principle to make distributions to beneficiaries, the definition of “vest” should be understood. It was held in the ITC 76 case of 1927 that “a vested right is something substantial; something which can be measured in money; something which has a present value and can be attached”.

A vested right is defined as “a right accrued to a possessor with no conditions” or, in the legal definition, “a right belonging completely and unconditionally to a person as a property interest which cannot be impaired or taken away without the consent of the owner”. A vested right cannot be conditional. A vested personal right to claim payment or transfer of the benefit will form part of the estate of the beneficiary. It cannot just be taken away. A beneficiary with a vested right has a right to claim an asset and/or income from the trustees, depending on the conditions attached to the vested right. Often trust deeds state that trustees do not have to make payments and can retain the amounts in the trust. Beneficiaries do, therefore, not have an automatic claim against the trustees for the payment of such amounts; the terms of the trust deed and the relevant trustee resolution have to be considered.

How the trustees must deal with distributed amounts

The trustees must carefully consider the provisions of the trust instrument when establishing what their specific powers are regarding making distributions – are they allowed to retain distributions once they have been made, and are they allowed to invest such retained distributions in the name of the trust, or must they invest them in the names of the relevant beneficiaries?

Even though the ownership of such a distribution lies with the beneficiary, often trustees retain it in the trust and invest it in the name of the trust rather than in the name of the beneficiary.

This equates to a loan to the trust from the beneficiary, to the extent of the amount that vested in that beneficiary.

In these circumstances, a loan agreement should be drawn up that stipulates the repayment terms, as well as whether it is interest-bearing or interest-free.

If the loan is interest-free or attracts interest at a rate below the variable official rate of interest, donations tax will be payable on the interest “donated” under Section 7C of the Income Tax Act, which taxes loans to trusts by “connected persons” in relation to those trusts (beneficiaries or “connected persons” in relation to such beneficiaries) with interest rates charged at below the variable official rate of interest.

If the investment or money is being held on behalf of the beneficiary, then no loan exists, since the beneficiary has a vested right in the investment or money, and any income or benefits arising from such investment will accrue directly to the beneficiary. Since Section 1 of the Income Tax Act defines “gross income” as “the total amount in cash or otherwise, received by or accrued to or in favour of that resident”, any income earned on the vested amount will be deemed income in the hands of the beneficiary and will accrue to the beneficiary.

The amount vested in the beneficiary will continue to grow within the trust, although the trust will not be taxed on such amounts - the beneficiary will. If no income is declared, it will, in all probability, be necessary to prove that the asset did not yield income.

Since no loan exists in this scenario, Section 7C will not apply.

SARS issued a binding private ruling (BPR 350) in August 2020 dealing with the tax treatment of the vesting of a capital gain in a beneficiary of a trust where payment of the capital gain is deferred at the discretion of the trustees and the capital gain is invested on behalf of the beneficiary.

SARS ruled that Section 7C would not apply to the proposed transaction but specifically confirmed that any subsequent income earned on the vested amount (or income apportioned to the vested amount against which enjoyment has been withheld) would accrue to the beneficiary and should be included in the gross income of the beneficiary.

Conclusion

It is therefore essential that trustees carefully word resolutions when amounts are awarded to beneficiaries, especially when these amounts are not actually paid over to beneficiaries at the time. It should stipulate all the terms of the decision in alignment with the trust instrument.

The trustees need a proper system to keep a careful record of the amounts retained, how these amounts were invested, and the income earned in respect thereof.

Trustees’ subsequent actions should also be in alignment with the resolution to avoid any unintended tax consequences.

Phia van der Spuy is a Chartered Accountant with a Masters degree in tax and a registered Fiduciary Practitioner of South Africa, a Master Tax Practitioner (SA), a Trust and Estate Practitioner and the founder of Trusteeze, the provider of a digital trust solution.