For tax purposes, a trust is considered to be a separate “person”. A trust will be considered to be resident for tax purposes if it is incorporated, established, formed, or has its place of effective management in South Africa.
Depending on the circumstances, trust income can be taxed in the hands of the donor, beneficiary, or the trust.
A grey area happens where a trust distributes a capital gain to a non-resident beneficiary. Trustees should thus seek advice before making capital distributions to non-resident beneficiaries.
Where income received by the trust is paid out to the beneficiaries within the same tax year, it is treated – for tax purposes – as if it had never been received by the trust, but instead directly by the beneficiaries. Distributions should therefore be made to the beneficiaries in the same year as income is received.
The trust acts as a conduit through which income flows. Income flowing through a trust to beneficiaries retains its identity. Therefore, interest received by the trust is also treated as interested received by the beneficiary and is thus taxed in the beneficiary’s hands.
Any income or capital gain paid to or vesting in a beneficiary will be taxed in the hands of that beneficiary. Income and capital gains generated within the trust can be distributed to the beneficiaries where they will be paying tax based on their personal income tax rates.
The Income Tax Act gives trustees the power to vest solely capital growth in a beneficiary, without awarding any assets to the beneficiary. One caution of this is that the growth awarded then becomes part of the estate of the beneficiary.
Further information on trust taxation
Dividends, which are tax-free, remain tax-free as they pass through the trust to a beneficiary. Distributions therefore retain their nature for tax purposes, provided they are distributed in the same tax year that the trust received them; otherwise they will be taxable in the trust.
Many trusts allow the trustees to award income and capital gains from different sources to different beneficiaries, which creates good planning opportunities. So, for example, dividend income can be awarded to one beneficiary, and interest income can be awarded to another.
There may be circumstances where it is necessary to create a trust that retains all of its income, resulting in it paying tax at extremely high rates. In these circumstances, it is best to rather invest the trust capital in endowments, equities and preference shares, which pay after-tax or tax-free dividends, so as to make the receipts in the trust non-taxable. It is important to note that once the trustees distribute large amounts of income and/or capital gains to beneficiaries in order to save tax, the estates of these beneficiaries will be inflated in value, and estate duty will become payable on their death on any amounts distributed, plus any growth from there onwards.