It seems it is/was a common practice amongst some trustees to pass resolutions for distributions to beneficiaries of the trust after the end of the financial year (typically around the time the financials are being finalised). It appears SARS has become aware of this and is holding the trust accountable for the income tax on those distributions as opposed to the beneficiaries, indeed even if the beneficiary declared the distribution and paid the tax on it.
The Conduit Principle?
But what about the conduit principle? Suffice it to state the principle only applies if the beneficiary has a vested right to the income received by the trust and that vested right was obtained by the beneficiary in the same year as the trust received the income in question. In the case of a discretionary trust, the trustees would need to exercise a discretion to create that vested right. If the trustees did not exercise that discretion before year end, the vested right is not created and then the conduit principle does not apply. The trust is then liable for the income tax.
This news may come as a surprise for some trustees. Once you have gotten over the realisation and possibly shock of the higher tax bill in the trust (compared to the tax bill in the hands of the beneficiary), get ready for the next issue.
Prescription and double tax
In practice, it seems that in many cases where the vested right was not created before the end of the financial year, the distribution was nevertheless declared in the hands of the beneficiaries and taxed accordingly. And, since this “vesting” after year end has seemingly been a practice for many years amongst some trustees, many of the beneficiaries’ assessments in which the distribution was taxed would have prescribed.
This leads to economic double tax (i.e the income is taxed in the hands of the trust and again in the hands of the beneficiary). But what about the presumption against double tax? Suffice it to state the presumption does not apply to economic double tax. It applies only to prevent the same amount being taxed in the hands of the same person more than once. It is arguably no defence – certainly not as a basis to get around prescription.
Understatement Penalties
Get ready for another shocker: when SARS raises these assessments on the trust to tax the trust, they tend to impose understatement penalties (which, to be fair, they have no choice of doing – assuming they have properly imposed the penalty, which is a discussion for another day). These can be as high as 200% though it seems the “go to” in these cases is 25%.
Unique Skills to resolve
These cases are an administrative nightmare and financial disaster for trustees and beneficiaries.
For those who have been investigated and found wanting: the challenge ahead is difficult to overcome.
It requires a detailed review of trust deed to determine how vesting is regulated, review of communications between trustees and reviews of financial data, to say the least, to determine if there is any merit to challenging SARS’ assessment and if there is no merits on the capital, figuring out how you deal with penalties in the trust and getting the tax paid by the beneficiaries back from SARS – none of which are easy tasks given the assessments are normally quite old. And, if you think “common sense” will prevail and SARS will not allow a result which is obviously economic double tax – think again. To be fair, if they believe their hands are proverbially tied (because the law is the law), the best you will get is something along the lines of “I hear you but there is nothing we can do about it – go ask the legislature to change the law” (which, to be fair, is a valid response sometimes – but not always).
For those who may not have been found wanting (yet):
Considering options such as VDP may be a good idea but then, nowadays, just rushing into VDP with the hope of just getting it over and done with may be very costly.
Indeed, this issue of the tax treatment and timing of assessments, conduit principle, prescription and VDP and double tax is a space where solutions require the unique and expert skills of professionals who specialise in two areas of taxation: Tax Dispute Resolution and Voluntary Disclosure Program applications.
These speciality areas are areas wherein Unicus Tax boasts a 100% success rate because indeed, they are our two main focus areas.
