Endunamoo Comprehensive CTA (ECC2016/W) Taxation (TAX4861/2) – Part II Term 2 Madodonke Mpetshwa | 29 March 2016

Trust

Objectives • Calculate the taxable income of all related parties to a trust in respect of amounts that accrue to the trust during the year of assessment • Calculate the taxable capital gain of all related parties to a trust resulting from a disposal of an asset by a trust • Apply the provisions relating to a non-resident trust when amounts are distributed during the current year as well as in a subsequent year of assessment

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Different categories of trusts • Mortis causa  Created ito a will  S7 not applicable since donor is deceased

• Inter vivos trust  Created during the lifetime of the founder  Usually created via donation and s7 therefore usually applies

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Tax rate of trusts • Special trust Par (a):  Inter vivos or Mortis Causa  Created solely for the benefit of persons with a disability as defined in s6B(1)

 Disability prevents sufficient earning of income  On death of all disabled persons, trust ceases being special trust from the beginning of the YOA  For CGT, remains a special trust until the earlier of disposal of all assets or 2 years after beneficiary’s death 5

Tax rate of trusts • Special trust Par (b):  Inter vivos or Mortis Causa  Created ito will of deceased person solely for the benefit of his relatives  Beneficiaries must be alive or have been conceived on date of death  Youngest beneficiary under 18 years on the last day of the YOA  Cease being a special trust where youngest beneficiary turned 18 in the current YOA. Cessation from beginning of YOA 6

Tax rate of trusts • Ordinary trust – NOT a special trust • Taxed at 41% • Special trusts taxed using the natural persons tax table • For CGT, special trust only includes par (a) special trusts

• Annual exclusion (par 5), Primary residence exclusion (par 45), exclusions for personal use assets and compensation for injury, illness or defamation. • Par (a) & (b) special trusts apply 33.3% inclusion rate • 66.6% for ordinary trusts. No annual & other exclusions 7

Nature of income received & distributed by trusts Conduit principle Armstrong v CIR (1938) 10 SATC 1 In Armstrong v CIR it was held that income that is the subject of a trust retains its identity until it reaches the parties in whose hands it is taxable, for example, the beneficiaries. A trust is a mere conduit pipe through which the income flows, and the income retains its identity in the hands of the beneficiaries

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Nature of income received & distributed by trusts Conduit principle SIR v Rosen (1971) 32 SATC 249 In SIR v Rosen the court held that the income must accrue to the beneficiaries in the same year of assessment as it accrued to the trust.

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Nature of income received & distributed by trusts Beneficiaries

Income A (eg dividends) Income B (eg interest)

Income C (eg rental)

TRUST (if Trustees distribute the income in the same year of assessment or beneficiaries have a vested right to the income)

Income A (dividends)

Income B (interest)

Income C (rental) 10

Persons liable for tax Subject to section 7, s25B(1) determines that income For a vested trust accrues to the beneficiary For a discretionary trust accrues to the trust

For a discretionary trust that has distributed the income to the beneficiaries, then amount accrues to the beneficiaries Order: Donor (s7(2) to 7(8)) -> Beneficiary (s25B(1) & (2)) -> Trust (s25B(1)) 11

Persons liable for tax Section 25B and Section 25B(1)  Section 25B applies to any amount received by or accrued to a person in his/her capacity as the trustee of a trust  For Section 25B(1) to apply, the amount must be: 1. Derived for the immediate or future benefit, 2. of any ascertained beneficiary, 3. who has a vested right to that amount during the year.  Where section 25B(1) applies, the amount will be taxed in the hands of the beneficiary, and not the trust 12

Persons liable for tax Section 25B(2)  Where the trustees exercise their discretion, and distribute income or capital to a beneficiary, a vested right is created  The amount shall be deemed to have been derived for the benefit of the beneficiary who acquires the vested right.  Verify if the 3 section 25B(1) requirements apply.  If they all apply, the amount is taxed in the hands of the beneficiary  If they do not all apply, the amount is taxed in the trust 13

Person liable for tax

Year 1: s 25B(1) or (2)

TRUST Retained in the trust? >Taxed in the Trust at 41%

Year 1 Rental income

Distributed to beneficiaries in year 2? >Capital receipt in the hands of the beneficiaries. 14

Liability of Donor S7(2) to 7(8) anti-avoidance measure Different person, than the person entitled or receiving the income, is taxed on the income Invoked if ‘donation, settlement or other disposition’ has taken place Interest-free loan (Continuous donation) Disposal of asset at less than market value

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Liability of Donor S7(2) – Deemed inclusion in spouse’s income • • •

Donation, settlement or other disposition Transaction, operation or scheme Sole or main purpose was reduction, postponement or avoidance of donor’s liability

•

Excessive amounts paid out of trade income of one spouse

•

Amounts received by a trust where spouse is a beneficiary

•

Par 68 – Attribution of capital gain to spouse 16

Liability of Donor S7(3) – Deemed inclusion in the income of parents of a minor child • Donation, settlement or other disposition • Income received or has accrued to or in favour of minor child • Expended or accumulated for the benefit of minor child

S7(4) – Deemed inclusion in the income of parents of a minor child • Donation, settlement or other disposition • Income received or has accrued to or in favour of ANY minor child • Parents of that minor child made a donation, settlement or disposition to the donor Par 69 – Attribution of capital gain to parent of minor child 17

Liability of Donor S7(5) – Retained income not vested due to stipulation or condition • Donation, settlement or other disposition • Subject to a stipulation or condition • Relating to vesting of income received or some portion thereof

Par 70 – Attribution of capital gain subject to conditional vesting

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Liability of Donor - Example Mr X donates R1m to a trust. The trust invests the money and earns R120 000 of interest for the year on a call account. The trustees (discretionary trust) decided to retain R85 000 of the income in the trust, and to distribute R35 000 to Mr X’s minor daughter. Solution: Tax implications

Amount

R120 000 generated from an asset donated to the trust, s7 will thus apply as follows: Mr X – s7(3) Income of minor child s7(5) Income retained in trust Gross Income

35 000 85 000 120 000 19

Liability of Donor - Example Mr X donated a fixed property with a MV of R500 000 to a trust in the 2015 YOA. The trust sold the fixed property in the 2016 YOA for R650 000. The trustees (discretionary trust) decided to retain R120 000 of the capital gain in the trust, and to distribute R30 000 to Mr X’s minor daughter. Solution:

Tax implications

Amount

R150 000 generated from the sale of the asset donated to the trust, attribution rules will thus apply as follows: Mr X – Par 69 Gain of minor child

30 000

Par 70 Gain retained in trust

120 000

Total capital gain

150 000 20

Liability of Donor S7(6) – Amounts vested that could have been revoked • Donation, settlement or other disposition • Income already paid or vested in a beneficiary • Donor retains right to revoke a beneficiary’s right to receive any income or confer that right to any other person

Par 71 – Attribution of capital gain subject to revocable vesting

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Liability of Donor - Example Mr X donates R1m to a trust. The trust invests the money and earns R120 000 of interest for the year on a call account. The trustees (discretionary trust) decided to retain R85 000 of the income in the trust, and to distribute R35 000 to Mr X’s major daughter. Mr X has reserved for himself the right to revoke his major daughter’s right to receive the income Solution: Tax implications

Amount

R120 000 generated from an asset donated to the trust, s7 will thus apply as follows: Mr X – s7(6) Income of major child s7(5) Income retained in trust

Gross Income

35 000 85 000

120 000 22

Liability of Donor S7(7) – Donation of the right to income • Donation, settlement or other disposition • Right to receive dividends, royalties, rent or similar income • Ceded to another person for that person’s benefit • Retains ownership of the asset • Deemed to have been received by or accrued to the donor

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Liability of Donor S7(8) – Resident benefiting a non-resident • • • • •

•

Donation, settlement or other disposition by resident Of foreign source income Amount received by or accrued to non-resident Income would have constituted income had that non-resident been a resident Income attributable to the donation will be included in the income of the resident

Par 72 – Attribution of capital gain vesting in non-resident 24

Interest-free and low-interest loans Case Law - CIR v Berold (SAICA) • “the taxpayer sold and transferred a large number of valuable assets to Luzen, he did so on credit without charging interest on the purchase price. In fact he lent a substantial sum of money to Luzen and as long as he refrained from compelling Luzen to repay that sum, there was a continuing donation by him to Luzen of the interest on that loan.” • This court held that the making of an interest-free loan constitutes a continuing donation to the borrower which confers a benefit upon such borrower. • As long as the capital remains unpaid the failure to charge interest represents a continuing donation 25

Interest-free and low-interest loans Case Law – CSARS v Woulidge (2002) (SAICA) • Woulidge had set up two trusts (one for each of his children). The shares in four companies were sold to these trusts for full consideration on a loan account. In terms of the sale agreement, the seller (Woulidge) could, if he so chose, charge interest on the loan capital that did not exceed the bank prime rate. In the years of assessment under consideration, and in the preceding years of assessment, no interest was charged on the outstanding balance of the loan. The terms of repayment of the outstanding capital sum were not fixed • After a company (‘C’), that was not a connected person with respect to Woulidge or his children, had become interested in the four companies held by the trusts, restructuring took place. The new group structure comprised a holding company that was installed between the holdings in the four companies and the trusts. Each trust then sold 50% of its holding to C for a sum which each trust used to repay the outstanding loan that was owing to Woulidge and to make loans and other investments. Income accrued as a result of these investments and the loans made by the trust; some of the income was distributed to the beneficiaries of the trusts (i.e. Woulidge’s children). The Commissioner sought to attribute the income from these investments to Woulidge 26

Interest-free and low-interest loans CSARS v Woulidge (2002) (SAICA) • The in duplum rule that prohibits the accrual of interest when the interest due exceeds the capital outstanding, does not apply to section 7 • But, paragraph 73 applies Joss v SIR; Ovenstone v SIR • Income that accrues as a result of a low-interest loan should be apportioned between the gratuitous and nongratuitous elements of the disposition

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Interest-free and low-interest loans – Example – Silke 27.10 •

• •

• • •

Mark created an inter vivos discretionary trust on 28 February 2015 by selling a rent-producing property to the trust at its market value of R10m. The purchase price was not paid by the trust but credited to a 2% interest-bearing loan account Market related rate is 5% Gross rentals R950 000 and tax deductible expenditure of R250 000 (includes the 2% interest) Mark’s minor stepdaughter and major son are the beneficiaries R10 000 of the net rental income distributed to each beneficiary in the 2016 YOA No vested right to retained income 28

Interest-free and low-interest loans – Example – Solution – Silke 27.10 60% of income relates to the low-interest loan (i.e. 3%/5%) Amount subject to s7 R300 000 (R10m*3%) Retained net rental of R680 000 (R950 – 250 – 10 – 10) subject to s7(5)

Amount subject to s7: Amount

S7(3) rentals to minor stepchild (R10k * 60%)

6 000

S7(5) retained rentals (R680k * 60%)

408 000

Total

414 000 29

Interest-free and low-interest loans – Example – Solution – Silke 27.10 • •

R414 000 subject to s7 limited to R300 000 (benefit enjoyed as a result of low interest) R114 000 taxed pro rata in the hands of stepchild R1 652 (R114k * R6k/R414k) and trust R 112 348 (R114k*R408k/R414k)

Mark’s minor stepdaughter: • Amount not subject to s7 • Pro rata of retained income

R4 000 R1 652

Mark’s major son: • Amount not subject to s7

R10 000

Trust: • Excess over s7 R112 348 • Amount retained(R680k*40%) R272 000 30

Trusts – s25B Section 25B and Section 25B(1) •

Section 25B applies to any amount received by or accrued to a person in his/her capacity as the trustee of a trust

•

For Section 25B(1) to apply, the amount must be: • Derived for the immediate or future benefit, • of any ascertained beneficiary, • who has a vested right to that amount during the year.

•

Where section 25B(1) applies, the amount will be taxed in the hands of the beneficiary, and not the trust 31

Trusts – s25B Section 25B(2) • • • • •

Where the trustees exercise their discretion, and distribute income or capital to a beneficiary, a vested right is created The amount shall be deemed to have been derived for the benefit of the beneficiary who acquires the vested right Verify if the 3 section 25B(1) requirements apply If they all apply, the amount is taxed in the hands of the beneficiary If they do not all apply, the amount is taxed in the trust

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s25B(3) Deductions • • •

Deductions / allowances on section 25B(1) income follow the income Deducted by the beneficiary, but subject to sections 25B(4) – (7) Otherwise ̶ deducted by the trust

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s25B(3) Deductions Limitation •

Deduction limited to beneficiary’s section 25B(1) income from the trust (section 25B(4))

•

Excess: deducted by the trust (section 25B(5))  but limited to trust’s taxable income  if trust not subject to SA tax  then carried forward for beneficiary

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s25B(3) Deductions Limitation •

Excess not deducted by beneficiary or trust  Carry forward to the next year for the beneficiary (section 25B(6))

•

If the beneficiary is not subject to tax in the Republic  Sections 25B(4), (5) and (6) are not applicable (section 25B(7))

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CGT on Trusts •

Donation or sale to a trust by a connected person: proceeds equal to market value (par 38)

•

Vesting of an interest in a trust asset in a beneficiary is a disposal (par 11(1)(d)) (see also par 13(1)(a)(iiA)) – Gain at the time of vesting is • disregarded in hands of the trust (calculate in the Trust and then disregard) • taxed in hands of resident beneficiary (par 80(1))  Subject to paragraphs 68, 69, 71 and 72 if applicable

•

Vesting of a capital gain in a resident beneficiary • disregarded in hands of trust (calculate in the Trust and then disregard) • taxed in hands of resident beneficiary (par 80(2))  Subject to paragraphs 68, 69, 71 and 72 if applicable 36

CGT on Trusts (Cont…) •

Capital losses can never be attributed to a donor – nor can they be set off against attributable capital gains prior to attribution, even if they arise in the same year of assessment from the same donation, settlement or other disposition; – nor can they be distributed.

•

Capital losses will therefore always remain in the trust (to be set off against future capital gains of the trust)

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Non-resident Trusts •

•

Taxed only on SA-source income but Section 25B(2A) inclusion in income of a resident beneficiary who — acquires a vested right to capital of a non-resident trust if — the capital arose from receipts and accruals of the trust that ⁻ would have been ‘income’ (as defined) if the trust had been a resident; ⁻ arose in a previous year of assessment during which the resident had a contingent right to the amount; and ⁻ not previously taxed in SA 38

Non-resident Trusts – CGT (Par 80(3)) Includes an amount in the aggregate CG/CL of a resident who – • acquires a vested right to capital of a non-resident trust, if • the capital arose from — a CG or an amount that would have been a CG of the trust if the trust had been a resident; — determined in a previous year of assessment during which the resident had a contingent right to the capital; and — the CG was not previously taxed in SA

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Trust Comprehensive Examples

Silke Comprehensive Example 27.18 Page 863

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Deceased Estates

Objectives • •

• • •

Explain the tax treatment of amounts of income earned after the death of a deceased Explain the tax treatment of amounts of income earned by the deceased before the date of death, but only received after date of death Explain how being married in community of property changes the situation in a deceased estate Understand the tax consequences for the beneficiaries of a deceased when they receive benefits from a deceased estate Understand the effect of CGT on a deceased estate

Deceased Taxpayer • Date of death i) ii)

cease to be a taxpayer normal tax on income prior to death

•

Executor or administrator appointed

•

Apportion s6 rebates

Amount received or accrued after date of death • Deemed receipt or accrual immediately prior to death i)

ii)

s8B share plans - No s8B normal tax on death - No s25 on sale of shares - CGT effect s8C equity instruments - Vesting date immediately before death - Only if, restriction can be lifted – s8C(3)(b)

Deemed disposal s9HA, s11(a) & s22 •

Death on or after 1 March 2016

•

Deemed disposal at market value – s9HA(1)

•

No deemed disposal: i) Surviving spouse ii)

Long-term insurance policy disregarded ito par 55

iii) Retirement fund disregarded ito par 54

Deemed disposal s9HA, s11(a) & s22 •

Surviving spouse •

Testamentary succession, Redistribution agreement & Matrimonial claim

•

Disposed of at: i) Expenditure allowed under s11(a) or 22

ii)

Base cost under paragraph 20

S25 – Income of deceased estate Normal Tax • Receipts or accruals to executor •

Receipts or accruals that would have constituted income during lifetime

CGT • S25(2) – Assets acquired at MV - s9HA(2) assets acquired at cost

S25 – Income of deceased estate CGT • S25(3) – Disposal to heir or legatee

i) ii) •

Proceeds equal to Base Cost Heir acquires @ DE base cost

S25(4) – Disposal to surviving spouse i) ii)

Date of acquisition – same as deceased spouse Expenditure – same as deceased spouse plus expenditure incurred by DE

S25 – Income of deceased estate CGT •

S25(6) – Heir or legatee can elect to receive an asset that must be disposed of to settle CGT i) ii)

CGT > 50% of Net Value of Estate Executor required to dispose to settle CGT

- Heir or legatee settles CGT within 3 years •

S25(5) – DE treated as a natural person i) ii)

S10(1)(i) interest exemption No s6 rebates or medical tax credits

Estates

Estate Duty Estate duty is payable on the following assets: •

South African residents > World-wide assets

•

Non-residents > South African assets

Estate duty: Framework Property in Estate - s3(2) Rxxx Deemed property in the estate - s3(3) xxx Gross value of the estate xxx Less: Allowable deduction - s4 (xxx) Net Value of Estate - s4 xxx Less: Abatement - s4A (3 500 000) Dutiable amount - s4 xxx Estate Duty calculated @ 20% of dutiable amount xxx Less: Applicable tax rebates (s16 and 1st Schedule) (xxx) Less: Amount of estate duty to be recovered from beneficiaries -(xxx) s13 Estate Duty payable by the estate xxx

Estate •

Property at the date of death and deemed property

•

Property • • •

– s3(2): Right Movable or Immovable Corporeal or Incorporeal

Estate •

Property – s3(2): •

Fiduciary, Usufructuary or other like interest in property (Incl annuity charged upon any property)

•

Right to an annuity (excl. annuity charged upon any property)

•

Excess contributions not qualifying for s11(k), par 2 of 2nd Schedule or s10C exemption

Annuities Section 3(2)(a) and (b) of the Act distinguishes between two types of annuities,

(i) an annuity charged upon property and (ii) an annuity not charged upon property.

(i) An annuity charged upon property Charged upon property' means that there is some particular property or fund out of which the annuity is payable, for example, the annuity is payable to the deceased by an executor or administrator or trustee out of funds which he is by will or deed directed to administer Two requirements must be met for it to be the property in the estate of a deceased, namely: • the annuity must have been charged upon property and • the annuity must have been held by the deceased immediately prior to his death

(i) An annuity charged upon property Section 5(1)(c) makes provision for the valuation of annuities charged upon property, namely: • where the right to the annuity (enjoyed by the deceased) accrues to some other person upon the death of the annuitant, the limited right will be based on the age of the beneficiary on his next birthday, after the death of the deceased; and • where the annuity does not accrue to some other person, but full ownership over the property becomes vested in the owner of the property on which the annuity was charged, the limited right will be based on the age of the owner of the property (on his next birthday, after the death of the deceased)

(ii) An annuity not charged upon property Annuity not charged upon property (any other annuity) means any right to an annuity except a right to an annuity charged upon property, which was enjoyed by the deceased immediately prior to his death and which accrues to some other person on the death of the deceased (annuitant). This type of annuity is not based on a specific property or capital fund but is the right to receive an annuity such as those which can be purchased from a life assurance company or which is paid out in terms of a pension fund. If the annuity does not accrue to another annuitant, the annuity enjoyed by the deceased will not be property in terms of s 3(2)(b)

Deemed Property – s3(3) Domestic insurance policies – s3(3)(a) • Proceeds from domestic insurance policy on deceased’s life •

•

Reduce by premiums paid by beneficiary plus 6% p.a. interest

S3(3)(a) not applicable if: • Paid to surviving spouse or child of deceased • Paid to partner or co-shareholder - Except: – policy not effected by or at the instance of the deceased - No premiums paid by deceased - No benefit to estate or relative

Deemed Property – s3(3) Donatio mortis causa – s3(3)(b)

• •

No donations tax – s56(1)(c) exemption S56(1)(d) exempt donation included

s3(3)(cA) – Matrimonial claims

s3(3)(d) – Deceased competent to dispose of for his benefit

Value of Property – s5 •

Liquidation – Realised price

•

Fiduciary, Usufructuary – Given

•

Annuity charged upon property

•

Annuity not charged upon property

•

Bare Dominium – FMV less usufruct

•

Property that deceased was competent to dispose of for his own benefit – Fair Market Value at death

Allowable Deduction – s4 •

Funeral & Death-bed expenses

•

Debts due within the Republic

•

Costs of administration & Liquidation

•

Master or Commissioner requirement costs

•

Foreign property

•

Debts due to creditors outside SA

•

Limited interest reverting to donor

Allowable Deduction – s4 (Cont..) •

Bequests to PBO’s or exempt persons

•

Improvements to property made by heir or legatee

•

Improvements to limited interest made by heir or legatee

•

Claims by spouses

•

Limited interest created by predeceased spouse

•

Books, pictures, statutory & other works of art

•

Deemed property taken into account to value shares

•

Amounts accruing to surviving spouse

Abatement – s4(A) •

R3 500 000 from net value of estate

•

Surviving spouse qualifies for predeceased spouse abatement less abatement used by predeceased spouse

•

Executor must submit ED return of predeceased spouse

•

Spouse’s simultaneous death – smaller net asset value spouse deemed to have died first

•

Multiple spouses – apportion equally among surviving spouses - Surviving spouse can only enjoy 1 predeceased spouse abatement

Other Rebates •

Transfer duty paid by beneficiary - s16(a) - Beneficiary liable for ED and Transfer Duty

•

Foreign death duties – s16(c)  ED payable on foreign property and death duties payable in other foreign country  Rebate of foreign death duties limited to SA Estate Duty

 Where there’s a DTA, relief sought under DTA and NOT s16(c) rebate

Other Rebates •

Rapid succession rebate – s2(2)  Rebate available on property subject to ED more than once within 10 years  First person died within 10 years  Second person paid ED on the property

 Rebate is a percentage of ED on the property in the estate of the second person Number of years Deceased dies within 2 years of the death of first person

Rate 100%

Deceased dies more than 2 years, but not more than 4 years after the death of the first person

80%

More than 4 years, but less than 6 years

60%

More than 6 years, but less than 8 years

40%

More than 8 years, but less than 10 years

20%

Other Rebates Number of years Deceased dies within 2 years of the death of first person

Rate 100%

Deceased dies more than 2 years, but not more than 4 years after the death of the first person

80%

More than 4 years, but less than 6 years

60%

More than 6 years, but less than 8 years

40%

More than 8 years, but less than 10 years

20%

Apportionment of ED – s11 •

Person liable for estate duty

 Fiduciary, usufructuary or like interest

-

Person to whom the advantage accrues on the deceased’s death

• Right to an annuity (other than annuity charged upon property)  Succeeding annuitant • Domestic policy of insurance on life of deceased  Person entitled to proceeds • Donatio mortis causa  Donee • Any other property  The executor

Married in community of property •

Assets and liabilities of both spouses constitute their joint estate

•

At death of one of the spouses, surviving spouse and deceased estate entitled to a half-share of joint estate

•

Estate of the deceased includes: - Half share of net joint estate - Property excluded from joint estate

•

Fiduciary or usufructuary of deceased spouse excluded from joint estate. Added to the net value of deceased estate

•

Liabilities arising only after death excluded from joint estate. Deducted in full in the estate duty of deceased spouse

•

Silke Example 30.18 – Estate of a person married in COP

Thank you Presenter’s details Madodonke Mpetshwa [email protected] +2711 056 6359

ECC2016 Administration E: [email protected] T: +2711 056 6359 M: +2784 282 3299 70