On 2 October 2024, the Constitutional Court of South Africa delivered a landmark judgment in the case of The Thistle Trust v Commissioner for the South African Revenue Service (CCT 337/22). The ruling significantly clarifies the tax treatment of capital gains in multi-tiered trust structures and limits the applicability of the conduit principle. This case will have far-reaching implications for trustees and beneficiaries in South Africa, particularly regarding the taxation of capital gains.
The Conduit Principle and Thistle Trust’s Actions
Under the conduit principle, trusts could pass on income or capital gains to beneficiaries, with the tax liability shifting to the beneficiaries who often enjoyed lower tax rates. Thistle Trust, as a beneficiary of several vesting trusts, received capital gains between 2014 and 2016 and passed them on to its beneficiaries. The Trust did not declare the capital gains in its tax returns, assuming that the beneficiaries, who paid tax at the lower 33.3% rate applicable to natural persons, should bear the tax burden. Trusts, however, are taxed at a higher 66.6% rate on capital gains.
The SARS Argument and the Court’s Ruling
SARS challenged this approach, arguing that the conduit principle does not apply to capital gains in multi-tiered trust structures, and that Thistle Trust itself should have declared and paid tax on the capital gains at the 66.6% trust rate. The Constitutional Court agreed with SARS, stating that Paragraph 80(2) of the Eighth Schedule of the Income Tax Act did not permit the application of the conduit principle beyond the first trust in a multi-tiered structure.
The Court’s ruling was clear: Thistle Trust was liable to pay tax on the capital gains at the trust rate, and the conduit principle could not be used to pass this liability on to beneficiaries through multiple layers of trusts.
Financial Impact on the Trust and Beneficiaries
As a result, Thistle Trust now faces the obligation to pay tax at the 66.6% rate, while its beneficiaries, who paid tax at the lower 33.3% rate, may apply for refunds from SARS for overpaid amounts. However, the process of reclaiming these amounts will depend on SARS’ administrative procedures.
This ruling underscores the importance of carefully reviewing trust arrangements and tax obligations. Trustees must now be aware that the conduit principle does not extend through multiple trusts, and they may face significant tax liabilities if they fail to account for this.
The Dissenting Judgment
A dissenting judgment by Bilchitz AJ, joined by Madlanga J, offered an alternative interpretation. The dissenting acting judges argued that Paragraph 80(2) of the Income Tax Act was ambiguous and should be interpreted in favour of taxpayers. Under this interpretation, the conduit principle would apply even in multi-tier trust structures, allowing the capital gains to be taxed in the hands of the beneficiaries rather than the trust.
The dissenting acting judges emphasised the importance of the contra fiscum rule, which requires ambiguous tax laws to be interpreted in favour of taxpayers. Bilchitz AJ further found that it was irrational to treat capital gains differently from other types of income, and that the law should promote consistency and fairness in tax treatment. According to the dissent, Thistle Trust’s interpretation of the law should have prevailed.
Quoted Sections of the Income Tax Act
The Court’s decision also rested on key provisions of the Income Tax Act, including Sections 25B and 26A. These sections governed the treatment of income and capital gains in trusts during the 2014 to 2016 tax years:
Sections 25B and 26A are headed ‘Income of trusts and beneficiaries of trusts’ and ‘Inclusion of taxable capital gain in taxable income,’ respectively. During the 2014 to 2016 tax years, which is the period relevant to this matter, these sections read as follows:
25B (1) Any amount received by or accrued to or in favour of any person during any year of assessment 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.
(2) Where a beneficiary has acquired a vested right to any amount referred to in subsection (1) in consequence of the exercise by the trustee of a discretion vested in him or her in terms of the relevant deed of trust, agreement or will of a deceased person, that amount shall for the purposes of that subsection be deemed to have been derived for the benefit of that beneficiary.
26A There shall be included in the taxable income of a person for a year of assessment the taxable capital gain of that person for that year of assessment, as determined in terms of the Eighth Schedule.”
In relevant part, paragraph 80(2) read as follows during the 2014 to 2016 tax years:
“[W]here a capital gain is determined in respect of the disposal of an asset by a trust in a year of assessment during which a trust beneficiary . . . has a vested interest or acquires a vested interest (including an interest caused by the exercise of a discretion) in that capital gain but not in the asset, the disposal of which gave rise to the capital gain, the whole or the portion of the capital gain so vested—
(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 for the purpose of calculating the aggregate capital gain or aggregate capital loss of the beneficiary in whom the gain vests.”
Conclusion and Recommendations
This case marks a turning point in the taxation of capital gains for trusts in South Africa. Trustees must now carefully assess the potential tax liabilities associated with capital gains and should no longer rely on the conduit principle to shield trusts from higher tax rates. We recommend that trustees consult with legal and tax professionals to review their trust structures in light of this judgment.
At Cowan Harper Madikizela, we are available to provide guidance on how this decision may affect your trust and tax planning strategies. For tailored advice, please contact us.
