Commissioner for SARS v The Thistle Trust (Case no. 516/2021 )

Facts:

The Thistle Trust (“the Thistle Trust”) is a beneficiary of various vesting trusts (“the Tier 1 Trusts”).

In the 2014, 2015 and 2016 tax periods, the Tier 1 Trusts disposed of certain capital assets. The capital gains so realised were distributed, inter alia, to the Thistle Trust in the same tax period. The Thistle Trust, in turn, in the same tax periods, distributed the amounts it received to its beneficiaries. It treated the proceeds received as taxable in the hands of its beneficiaries.

SARS raised an additional assessment dated 21 September 2018 for the period 2014, 2015 and 2016, taxing the amounts received by the Thistle Trust as taxable in its hands. SARS also imposed an understatement penalty against the Thistle Trust and required it to pay interest on the assessed liability.  

Issues:

Issue 1: Whether the capital gains accrued as a result of the disposal of capital assets by the Tier 1 Trusts are taxable in the hands of the Thistle Trust or in the hands of the beneficiaries of the Thistle Trust to whom those gains were distributed.

Issue 2: Whether the understatement penalty was correctly imposed.

Discussion:

Issue 1:

Two possible interpretations of the legislation were submitted. In SARS’s view, the above fell exclusively into the ambit of paragraph 80(2) of the Eighth Schedule.

In the Thistle Trust’s view, the above fell into the ambit of both paragraph 80(2) of the Eighth Schedule and section 25B, and the two provisions should have been read together.

To illustrate the differing effect each view results in, regard must be had to the wording of the relevant provisions.

Paragraph 80 of the Eighth Schedule provides for capital gain attributed to a beneficiary as follows:

‘80(2) …where a trust determines a capital gain in respect of the disposal of an asset in a year of assessment during which a beneficiary of that trust…who is a resident has a vested right or acquires a vested right…to an amount derived from that capital gain but not to the asset disposed of, an amount that is equal to so much of the amount to which that beneficiary of that trust is entitled in terms of that right—

(a) must be disregarded for the purpose of calculating the aggregate capital gain or aggregate capital loss of the trust; and

(b) must be taken into account as a capital gain for the purpose of calculating the aggregate capital gain or aggregate capital loss of that beneficiary.’ (Emphasis added.)

Section 25B reads:

‘25B(1) Any amount (other than an amount of a capital nature which is not included in gross income or an amount contemplated in paragraph 3B of the Second Schedule) received by or accrued to or in favour of any person …in his or her capacity as the trustee of a trust, shall… to the extent to which that amount has been derived for the immediate or future benefit of any ascertained beneficiary who has a vested right to that amount during that year, be deemed to be an amount which has accrued to that beneficiary, and to the extent to which that amount is not so derived, be deemed to be an amount which has accrued to that trust.‘

The effect of only paragraph 80(2) applying is that any capital gain determined by the Tier 1 Trusts will have to be accounted for by the Thistle Trust and it will not be possible for the Thistle Trust to on-distribute the capital gain to its beneficiaries. This is, in part, due to the provision referring to ‘the trust which determined the capital gain’, and ‘the beneficiary of the trust which determined the capital gain’. In no uncertain terms, it is the Tier 1 Trust which determined the capital gain on disposal of the assets. The capital gains are therefore trapped in the hands of the Thistle Trust (and subject to tax at effectively 36%) rather than in the hands of its beneficiaries who would likely be subject to tax at a lower rate (i.e.18%).

The effect of section 25B(1) also applying is that the capital gain would be taxed in the hands of the beneficiaries of the Thistle Trust rather than in the trust itself. Due to the wording of this section, provided the Thistle Trust exercised its discretion to vest the capital gain in its beneficiaries in the same year of assessment in which it received it, the capital gain would ‘pass through’ it into the hands of the beneficiaries and in line with the “conduit principle”.

As recently as 18 March 2021, and on a similar fact pattern, the ABC Trust in the case of ABC Trust v The Commissioner for the South African Revenue Service (Case no. IT 24918) succeeded in arguing that the capital gains received by it stood to be taxed only in the hands of its beneficiaries. At the time, the wording of section 25B(1) which simply referred to “any amount” was concluded to be sufficiently wide to include capital gains.

Shortly thereafter section 25B(1) was amended to clamp down on this result. The concept of “any amount” is now qualified to exclude amounts of a capital nature.

Given the clear cut amendment of section 25B(1), the court upheld SARS’s appeal and found that the tax court erred in finding that section 25B applied.

Issue 2:

On the basis that SARS was correct to raise the additional assessments, and that the taxpayer had understated its taxable income in its tax returns, SARS was entitled to levy a penalty dependent on the circumstances giving rise to the understatement.

Initially, SARS imposed a penalty of 50% on the basis of ‘no reasonable grounds for the tax position taken by the taxpayer’.

However, upon finding that the Thistle Trust had obtained a legal opinion to support its position, SARS conceded that the understatement was bona fide and inadvertent error as it had believed that section 25B was applicable to its case. Accordingly, it was held that SARS was not entitled to levy the penalty.

Find a copy of the case here.

Author

Tarynn Isaacs

18/11/2022