A complicated part of a trust is its tax treatment, the fact that it is a taxpayer of last resort.
This means other taxpayers may have to reflect trust generated income and capital gains in their tax returns rather than the trust on its tax return.
This may affect provisional tax returns (due at the end of August and February each year) and annual tax returns.
Given the recent changes to trusts in South Africa and with the South African Revenue Service (Sars) zooming in on trusts, taxpayers and tax practitioners need to heed the warning below.
Donors/funders of trusts
Few people are aware of or apply the attribution rules applicable to donors/funders of trusts. This is certainly not a new requirement. It has been in place for many decades. These rules are the first step to determine who pays tax on trust income and capital gains. Historically, lots of taxpayers and tax practitioners have (conveniently) gotten away with not applying the attribution rules and incorrectly distributed income and capital gains to, for example, minor beneficiaries who pay little or no tax.
That clearly resulted in a great tax leak for Sars. Sars, therefore, in recent communication, indicated that they will now get a handle on donors/funders of trusts. Additional questions were added to the Income Tax Return Wizard, effective 23 June 2023, to determine if amounts were deemed to have accrued to a donor/funder in terms of Section 7 during the relevant year of assessment. Such donors/funders (where the deeming provisions of Section 7 apply) must declare trust income and capital gains ‘attributed’ to them. This is a complicated cumulative calculation. Taxpayers who now, for the first time, include attributed amounts in their tax returns (both provisional and annual tax returns) are cautioned as they may face questions and penalties from Sars. A solution may be to use Sars’ Voluntary Disclosure Programme, which is a unique opportunity for defaulting taxpayers to regularise their tax affairs.
Beneficiaries of trusts
Only after the application of the attribution rules may trustees distribute remaining trust income and capital gains to beneficiaries through the ‘conduit principle’, resulting in those beneficiaries having to include that in their respective provisional and annual tax returns. Beneficiaries impacted by trusts which have not correctly applied the attribution rules discussed above may have to reopen their returns. From next year, with the first applicable tax year being March 2023 to February 2024, distributions made to beneficiaries have to be reported to Sars by the trustees on IT3(t)’s. Sars is in a process of testing until September this year and will thereafter communicate final requirements relating to the relevant forms and processes.
IT3(t)’s have to be submitted by all trusts, excluding Collective Investment Schemes and Employment Share Incentive Scheme Trusts. Sars requires the reporting of amounts vested in beneficiaries, which includes income net of expenditure, capital gains and capital amounts. Sars will use this information, similar to information provided by banks and others, to pre-populate taxpayers’ tax returns. Information that beneficiaries reflect on their tax returns will have to balance back to the IT3(t)’s. IT3(t)’s have to be submitted by trustees by 31 May each year; this date is before the trust’s tax return is due. This will require trustees and tax practitioners to stay on the same page on an ongoing basis to ensure that trust income and capital gains are treated correctly, not waiting until the financial statements are prepared much later.
The trust
The trust is the taxpayer of last resort. That means that the trust will only get taxed on whatever is left in the trust after taking into account income and capital gains attributed to donors/funder and distributed to beneficiaries; in laypersons’ terms, the balancing entry. Depending on when the ‘balancing entry’ income and capital gains were generated in the trust (before or after 31 August), the trust may or may not have to submit tax returns as a provisional taxpayer. That means by August each year, trustees and taxpayers have to ensure that they know exactly who is to include the income and capital gains in their respective provisional tax returns. No longer can trustees leave the trust’s finances for years before looking at it.
Mindful of auto-assessments this year
Sars implemented an auto-assessment process for taxpayers whose tax affairs are less complicated. Third-party data providers such as employers, medical schemes, banks, retirement annuity funds, and other institutions already provide them with information, which they use to pre-populate tax returns. Since 1 July 2023, Sars issued auto-assessments. Basically, if you are in agreement with your auto-assessment and it is complete, then there is no need to “accept” the assessment.
Note, however, that for this year, no trust distributions will be automatically reflected in tax returns, as they will only be submitted to Sars on IT3(t)’s from next year. Donors/funders to trusts also have to correct their returns as there is no way for Sars to collect this data. It will remain the responsibility of the donors/funders and beneficiaries to ensure their tax returns reflect amounts attributed or distributed to them. This is sometimes challenging, as trustees do not always communicate the amounts as they should, leaving the donors/funders and beneficiaries compromised.
If you need to add missing information or are for another reason in agreement with the auto-assessment, you will have until 23 October 2023 to correct the tax return. If an auto-assessment has been issued after 23 October 2023, you will be given 40 business days after the date of the notice of the assessment to correct the tax return. If a taxpayer has amended their tax return, they may possibly be selected for verification or, where appropriate, for audit. It is, therefore, very important that you have supporting documents for any changes you make to your auto-assessment.
Depending on the outcome of an auto-assessment, the taxpayer may owe Sars, or Sars may owe them a refund. Sars promises on their website that in the event of refunds due by Sars, they will refund the taxpayer within 72 hours. If donors/funders and beneficiaries have, however, not corrected their tax returns with amounts attributed or distributed to them during the tax year, it may result in Sars paying refunds which were not due. Sars may then levy penalties and interest on such undeclared amounts when they get to know them, i.e. when the trust’s tax return is submitted indicating amounts attributed to donors/funders and distributed to beneficiaries.
Trustees, tax practitioners, donors/funders and beneficiaries have to compare notes before they submit any tax returns. Donor/funders and beneficiaries should also not blindly accept auto-assessments or just leave them after they receive them. All these taxpayers should have relevant information handy so that are in a position to quickly adjust their tax returns, especially to stop Sars from paying a refund that may not be due.
* 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 and the founder of Trusteeze®, the provider of a digital trust solution.
PERSONAL FINANCE