Many boards of trustees, now third-party data providers to the South African Revenue Service (SARS) through reporting beneficiary distributions, remaining ultimately responsible, are turning to their accountants/tax practitioners for guidance.
These professionals play a crucial role in navigating the complex information required for the IT3(t) form, which can only be submitted once the trust financial statements are finalised.
If done properly and correctly, it takes a great effort to create correct, complete trust information in a format that facilitates the unique trust tax treatment described below. The IT3(t) is just one of several returns to be submitted to Sars, reflecting income and capital gains generated by the trust.
Why have Sars made trustees third-party data providers?
After Sars, during 2022, performed a reconciliation between distributions (“vestings” for tax purposes) to beneficiaries per the trust tax returns and distributions reflected by beneficiaries on their tax returns, a material gap was identified (some speak about amounts between R58bn and R65bn), resulting in Sars losing out on taxes. Cleverly, Sars decided to pick the low-hanging fruit by introducing the IT3(t), which requires trustees to report distributions to Sars to close this gap. Sars plans to use this information to pre-populate the beneficiaries’ tax returns with this information or re-open the already submitted/auto-assessed returns.
On whose tax returns should the income and capital gains generated in the trust be reflected?
The complexity of treating trust income and capital gains is often underestimated. Uniquely, other taxpayers may pay tax on income and capital gains generated in the trust rather than the trust itself. Strict rules have to be followed to remain compliant with the law. In summary, tax on income and capital gains generated in a trust are payable in the following (compulsory) order, and these taxpayers and the trustees have to communicate with one another to ensure that amounts are correctly reflected in the respective taxpayers’ various tax returns:
Firstly, the compulsory “attribution rules” are to be applied. If a person made a donation to the trust, or where the South African resident individual retains certain rights in the trust instrument, all income and capital gains resulting from such a donation (or on trust assets, the person retains the right) will be taxed in the hands of that person until their death, instead of the trust itself or its beneficiaries.
If a loan at a below-market interest rate was made to that trust by a person, income and capital gains generated resulting from such a gratuitous disposition, limited to the interest saved by the trust as borrower (this is the benefit caused by the non-charging of interest or the charging of interest at a below-market interest rate) will be taxed in the hands of that person until their death, instead of the trust itself or its beneficiaries (Section 7 anti-avoidance provisions of the Income Tax Act and Paragraphs 68 to 73 of the Eighth Schedule to the Income Tax Act).
This complex, cumulative calculation must be performed, which may cause difficulty for trustees/tax practitioners who have not historically applied these rules. Often, accounting records do not contain sufficient detail to facilitate the application of these attribution rules.
Trustees must keep proper systems in place to manage the required information effectively. With Sars’ renewed focus on the compulsory application of the attribution rules, some trustees and tax practitioners will have difficulty explaining why they have never applied them, causing Sars to be out of pocket. Standard practice involved blindly distributing all income and capital gains to beneficiaries who paid little or no tax. This caused Sars to lose out on the collection of taxes.
To pinpoint the correct persons (other than beneficiaries) who must pay tax on amounts generated in the trust, Sars decided to include these amounts attributed to donors/funders on the new IT3(t) submission. So, it is a misconception that the IT3(t) only deals with amounts distributed to beneficiaries.
Trustees need to communicate these amounts to the relevant donors/funders timeously so that they can include them in their provisional and annual tax returns to avoid interest and penalties on incorrect returns submitted. Loans triggering these provisions may also trigger Section 7C Donations Tax due to low or zero interest being charged on these loans. Donations Tax is payable to SARS by March 31 each year. Funders need to compare notes with the trustees that they report these loan amounts consistently to SARS.
After the application of the attribution rules above, to the extent that these anti-avoidance provisions do not apply, the trustees may distribute income or capital gains to the beneficiaries (in the same financial year) and use the “Conduit Principle” to have it taxed in the hands of the beneficiaries at potentially more favourable tax rates (Section 25B of the Income Tax Act for income distributions, and Paragraph 80 of the Eighth Schedule to the Income Tax Act for capital gains distributions). In many instances, trustees ignored the requirement that Sars would only recognise these “vestings” if they were made in the same tax year that they were generated.
Trustees are not allowed to date distribution resolutions after the end of the tax year (end of February each year). Historically, trustees “backdated” resolutions to pretend they made the distributions before the trust’s tax year-end. Sars cleverly introduced a requirement for trustees to submit their resolutions, and they are particularly interested in this resolution.
Sars warned that they would apply technology to determine the date it was generated. This should be a warning to trustees to no longer “backdate” resolutions as these transactions may be disregarded by Sars, leading to penalties and interest being charged. Distributions (income, capital gains, and capital) need to be reported on the IT3(t). Trustees need to communicate these amounts to the relevant beneficiaries timeously so that they can include them in their provisional and annual tax returns to avoid interest and penalties on incorrect returns submitted.
Lastly, if income or capital gains are not attributed to donors/funders or distributed to beneficiaries, only then will the remaining income or capital gains be taxed in the hands of the trust. Therefore, this is the balance of the income and capital gains left in the trust on which the trust will be taxed.
Conclusion
Even though the IT3(t)’s are due by September 30, 2024, the trustees must have finalised, detailed financial statements by then. They also have to perform a reconciliation between amounts to be reported on the IT3(t) and amounts reported/to be reported by donors/funders, beneficiaries, and the trust in their respective provisional tax returns, annual tax returns, and donations tax returns. Sars is closing the net, preventing a leak in its revenue, and will compare all the relevant parties’ tax return submissions to ensure the correct persons are taxed and that it collects taxes due to it.
* Phia van der Spuy is a Chartered Accountant with a Masters degree in tax and a registered Fiduciary Practitioner of South Africa®, a Chartered Tax Adviser, a Trust and Estate Practitioner (TEP) and the founder of Trusteeze®, the provider of a digital trust solution.
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