Katy Bolton
by Katy Bolton
The conduit principle is one which is well established in South African law dating as far back as 1938, introduced by the seminal case of Armstrong v Commissioner for Inland Revenue 1938 AD 343. In summary, the conduit principle states that income which has accrued to or is received by a trust on behalf of its beneficiaries retains its identity. This means that where the income vests in the beneficiaries in the same year of assessment as it accrued to the trust, such income will be taxed in the hands of the beneficiaries and not in the trust itself.
Initially a common law principle, it was later incorporated into the Income Tax Act 58 of 1962 (‘the Act’) by the insertion of both section 25B and para 80 of the Eighth Schedule of that Act. As a result, it is evident that the conduit principle is one which is firmly cemented in South African trust and tax law.
Recently, in the case of Commissioner, SARS v Thistle Trust (516/2021) [2022] ZASCA 153 (“the Thistle case”), the South African Revenue Service (‘SARS’) challenged the application of this principle to tiered trust structures, specifically in the context of capital gains (‘CG’).
Briefly, the facts of the case were as follows: Ten vesting trusts, collectively known as the Zenprop Group, and referred to as “tier 1” trusts, carried on business as property owners and developers. In the 2014 to 2016 assessment years, these tier 1 trusts disposed of capital assets which gave rise to CG, which vested in The Thistle Trust in the same year of assessment. The Thistle Trust in turn vested the CG in its natural person beneficiaries in the same year of assessment, who in turn declared and paid CG.
SARS, however, raised an additional assessment, taxing the amounts received by The Thistle Trust in its hands at the rate of 36 percent. Thistle objected to this, relying on the conduit principle as contained in the Act, whereby the CG should be taxed in the hands of The Thistle Trust’s beneficiaries.
The tax court found in favour of The Thistle Trust, upholding the long established conduit principle. SARS appealed this decision, and the issue before the Supreme Court of Appeal (‘SCA’) was whether the CG was taxable in the hands of the trust or in the hands of the beneficiaries.
In a controversial decision, the SCA found that the CG was taxable in the hands of The Thistle Trust. The reason for this was because on a reading of paragraph 80 the court found that a trust was to “determine a capital gain” before the conduit principle could apply. Thistle fell out of the ambit of the section as it did not itself dispose of any asset nor determine any gain, but rather it distributed funds that had vested in it by virtue of a right, due to the vested nature of the tier 1 trust.
The implications of this are that where one trust is a beneficiary of another trust, and has a vested right to and receives a CG, this gain cannot be further distributed and will be taxed in the hands of that trust rather than in hands of the ultimate beneficiary. It is argued that this case could have far reaching consequences for trust and trust company structures that have made use of the conduit principle since its fortification into law, limiting taxpayers to structure their affairs accordingly.
Nolands is an international auditing firm located in eleven offices in all major centres in Africa. Nolands employs almost 200 people and focuses on providing the best possible solutions for its clients. The company prides itself on being “not ordinary” and on its ability to integrate services and respond rapidly to clients’ needs.
Katy Bolton is a Senior Tax Consultant at Nolands Tax. She is an admitted attorney of the High Court of South Africa, with her highest qualification being a Masters in Commercial Law. Her interests in tax range from individual estate and tax planning to corporate tax and she is currently completing her Masters in Tax Law at the University of Cape Town. Contact Katy.
GGI member firmNolands TaxCape Town, South AfricaT: +27 21 658 6600Advisory, Fiduciary & Estate Planning, Tax
