VERTIDOS DE PETRÓLEO A LOS RÍOS

The DTC submitted in their First Report that the original intention of the attribution rules contained in s 7 of the Income Tax Act was to prevent taxpayers prior to the 1999 tax year from using South African resident trusts as income-splitting devices. This was done by placing income-generating investments in a number of trusts in order to take advantage of the tax regime applicable to resident trusts in those years (a sliding scale with the same maximum marginal rate as for individuals) and thereby avoiding the extremely high individual tax rates that prevailed at the time (which could be as high as 78%)353_.

After the introduction of a flat rate of tax for trusts in 2003 equal to the highest marginal tax rate for individuals and the same high CGT inclusion rate for trusts as applies to companies (introduced in 2001), the DTC submitted that section 7 no longer served its purpose as an anti-avoidance provision. They submitted that, in fact, the opposite effect occurred in that high-net-worth individuals were now able to avoid the high taxes payable in a trust through use of this section354_{. Together with the working of s 25B and by making}

distributions to several beneficiaries having lower levels of taxable income, income- splitting could therefore still be achieved through the use of trusts which is why the DTC wished to combat income-splitting by suggesting a repeal of both s 7 and s 25B (including, it is presumed, the related CGT paragraphs).

Under current tax legislation, income-splitting occurs where the total income and gains realised in a trust are split into smaller distributions made to each trust beneficiary. Since only a portion of the total trust income will now be included in each beneficiary’s tax return and as some beneficiaries may be minors with no other sources of income who are taxed at the lowest marginal tax rate, the effective tax rate at which the trust income and gains will be taxed will be lower than if all the trust’s income and gains were lumped together and included in the tax return of a single beneficiary (for instance, the founder) who may also have other sources of income and who may be paying tax at the highest marginal tax rate.

352 _{Para 56(1)(a)(i) of the Eighth Schedule to the Income Tax Act} 353 _{Davis Tax Committee 2015:37}

Income-splitting, in the context of trust assets originally transferred to the trust by the founder via loan account (and not by donation), is mainly achieved by making use of s 25B (the conduit principle) which deems trust income that was distributed to a beneficiary to be taxed in the hands of such beneficiary (therefore such income is not taxable in the trust).

Due to the high capital gains inclusion rate and flat income tax rate applicable to trusts, capital gains are currently effectively taxed at 32.8%355 _{if it remains in the trust. It is often}

such gains that are distributed to individual beneficiaries (using para 80 of the Eighth Schedule, the CGT equivalent of the conduit principle) as the effective tax rate for capital gains for individuals ranges only between 7.2% and 16.4%356 _{before taking into account}

the effect of any normal tax rebates per s 6 of the Income Tax Act357 _{(that is, at worst only}

half of the capital gains tax due compared to such gains remaining in the trust).

As South African income taxes levied in respect of individuals are based on a progressive, marginal tax rate, the effective tax rate for an individual will rarely be at the highest bracket’s tax rate of 41%. At the highest tax bracket of R701,300358 _{(from which amount}

all additional taxable income will be taxed at 41%) the effective tax rate, based on the 2016/2017 tax tables and assuming a primary rebate of R13,500359_{, will only be}

approximately 27.59% with a corresponding effective capital gains tax rate of 40% x 27.59% = 11.04%. For illustrative purposes, at just over double that amount, for an annual taxable income of R1,5 million the effective income tax rate based on the same

assumptions is approximately 34.73% and the corresponding effective capital gains tax rate equals approximately 13.89% (= 40% x 34.73%).

355 _{Refer Table 1 below}

356 _{Refer Table 1 below}

357 _{In other words, the final effective tax rate for capital gains may range from 0% after the} application of the normal tax rebates of s 6 of the Income Tax Act.

358 _{Rates and Monetary Amounts and Amendment of Revenue Laws Bill (Draft) 2016 (in respect of} taxable income of any natural person)

359 _{Section 4(1) of Rates and Monetary Amounts and Amendments of Revenue Laws Bill (Draft)} 2016

Table 1 – Comparative tax rates between individuals, trusts and companies

Type of income Taxpayer

Income tax rate360

Capital gains effective tax rate361

(capital gains inclusion rate362 _x

income tax rate)

Dividend withholding tax

rate363

Individual Varies from

18% to 41% = 40% x (18% to 41%) 7.2% to 16.4% 15% Company 28% = 80% x 28% 22.4% 0% Trust 41% = 80% x 41% 32.8% 15%

The above table therefore illustrates why there would be a tendency for trustees to ensure that any income or capital gains realised in a trust are distributed to individual

beneficiaries in order to enjoy the lower tax rates applicable to individuals. If the trust income is furthermore split between multiple individual beneficiaries then the overall effective tax rate can be kept low despite the fact that the total net taxable income may have attracted a higher effective tax rate if taxed as a whole or in the hands of a single beneficiary.

The common law principle that taxpayers are allowed to organise their financial affairs in a manner that will result in a reduction of the tax legally payable under the appropriate tax Acts, was established in cases like IRC v Duke of Westminster364_{and Dadoo Ltd and}

others v Krugersdorp Municipal Council365_.

360 _{Rates and Monetary Amounts and Amendments of Revenue Laws Bill (Draft) 2016}

361 _{These are the effective tax rates calculated before taking into account the effect of any normal} tax rebates per s 6 of the Income Tax Act.

362 _{The taxable gain inclusion rates given above are as per para 10 of the Eighth Schedule to the} Income Tax Act as to be amended by the promulgation of the Draft Rates and Monetary Amounts and Amendments of Revenue Laws Bill 2016 (s 10 of the Bill) and applicable in respect of years of assessment commencing on or after 1 March 2016.

From 1 March 2012 to 29 February 2016 the capital gains inclusion rate for individuals was 33.3% and for companies and trusts, 66.6% (Rates and Monetary Amounts and Amendments of Revenue Laws Act 2015).

363 _{The income from which dividends are paid are effectively taxed at 28% in the company and then} again with 15% dividend withholding tax when declared as a dividend to a non-exempt

shareholder. Therefore the overall tax rate collected on such income (paid by different parties) would be equal to 1 – (1 – 0.28) x (1 – 0.15) = 38.80%. If a company forms part of an overall structure of a taxpayer or group of taxpayers then this effective rate needs to be taken into consideration.

364 _{[1936] AC 1} 365 _{1920 AD 530}

The short-term tax benefits achieved by so-called income-splitting practices and regular distributions on loan account to individual beneficiaries should be weighed up against the effect this may have on the ability to protect the wealth held in the trust from third parties as well as on the eventual estate duty liability of such amounts for the founder and beneficiaries. As noted in the section on loan accounts above, the amount of distributions and amounts due to beneficiaries on loan accounts would be assets in the hands of the beneficiaries’ personal estates, which could be attached by third parties through a court order and would also constitute dutiable assets in their estate upon their demise. Large distributions and loan accounts could therefore partially undo the protection of wealth provided by a trust if a trust has to liquidate trust assets in order to pay out a beneficiary’s loan account to a third party on behalf of that beneficiary as a result of such a court order. Additionally, the short-term income tax benefits achieved by distributing large amounts of income to beneficiaries over time may be undone in the end by an excessive estate duty liability arising from large remaining loan accounts on death.

4.7.6 Considerations for resident beneficiaries’ interactions with non-resident trusts