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Pour Over Trusts - Income Tax Loophole |
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LOOPHOLE IN THE INCOME TAX ACT
I have heard that the Receiver of Revenue has issued a ruling in regard to Section 7(8) of the Income Tax Act vis-a-vis the Amnesty. Section 7(8) is a deeming provision whereby any person who has donated assets to a foreign trust is liable to pay tax on any resulting income received by such foreign trust. This Section was first promulgated under Section 9D as of the 1st of July 1997 so as to relate to foreign income then taxable in South Africa i.e. basically interest earned on monies left in bank accounts but was reinserted with effect from 1st January 2001 when the new residence based system of taxation became applicable. Thus it now relates to all income accruing to trusts as a result of a donation by a resident donor.
Such donations created a conceptual problem for the creators of the Amnesty Process in that the first Draft Bill specifically excluded all donations from its ambit. It was then realised that the majority of monies that had left our shores in contravention of Exchange Control had subsequently found their way into trusts and that an Amnesty without reference to such donations would not be taken up by the vast majority of people affected.
In the result Section 4 was introduced into the second draft whereby persons who had so donated monies to a trust could likewise apply subject to effecting payment of a 2% levy relating to such donation. That person was then deemed to hold that foreign asset as from the 1st March 2002 for the purposes of the Income Tax Act i.e. as from that date any income accruing would be deemed to be income accruing to that person and likewise for any capital gain Section 7(8) was then specifically excluded.
The ruling provides that Section 7(8) insofar as it relates to donations to trusts before the 1st of July 1997 will not apply to such assets if they are “poured over” into a new Trust. As donations prior to that date would not have resulted in any income tax consequences to the donor the position is continued in that a distribution by such a trust to a further trust will not result in Section 7(8) coming into play.
The ruling also puts to rest the concern that if assets are subsequently distributed by an amnestied Trust, the distribution would then be deemed to be a donation by the donor (i.e. as a person holding the monies in terms of Section 4 of the Amnesty Act) to a further trust. The Receiver has confirmed that this will not be the position because of the provisions of Section 4(3)(a) namely that where a distribution takes place from such an amnestied trust “the donor is deemed to have disposed of that foreign asset for a consideration equal to its market value on the date of the disposal …..” In other words no donation settlement or other “disposition” arises.
The consequence of all this is twofold. Firstly if the trust assets in respect of which Amnesty was sought related to a pre-1st July 1997 donation, Section 7(8) will never be applicable albeit if the assets are left in the Amnestied Trust, Section 4 will continue to deem them (and their income) to be the Donors. Secondly if the trust relates to assets donated post-1st July 1997 and the assets are distributed to a further trust, while such distribution will not constitute a “donation settlement or other disposition” because the disposal is deemed to be effected at its market value, the Receiver may revert to the original donation post-1997 and re-impose Section 7(8) treating the income as the donor’s. In the result any investor who obtains Amnesty relating to the donation of assets to a trust pre-1st July 1997 can avoid income tax for which he would otherwise be liable in terms of Section 7(8) where the assets from the Amnestied Trust are transferred to a new trust.
For tax purposes this is a fairly significant loophole but I have no doubt that it will be closed by the tax authorities shortly with new legislation. In the meantime investors will no doubt make hay!
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