Application of Attribution Rules for Trusts

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Application of Attribution Rules for Trusts

• 03 June 2024
• Trusts
• Cheryl Howard

In the intricate web of South African tax law, Section 7 of the Income Tax Act stands out for its deeming provisions, commonly referred to as the Attribution Rules. These rules are pivotal in the taxation of trusts, designed to prevent tax avoidance through income or asset transfers. 

The Attribution Rules apply to tax the donor / funder of a trust first – it is not so much who formed the trust but who funded or capitalised the trust that counts. If an amount is not taxable in the hands of the donor because the Attribution Rules do not apply, the amount may then be taxed in the hands of the beneficiaries of the trust, either as a distribution or a vesting of income or lastly in the trust as a taxpayer of last resort. The same amount will not be taxed in the hands of the donor and again in the hands of the beneficiaries if distributed or vested to the beneficiary. 

Attribution Rules typically arise when a trust receives income or assets from a donor under favourable terms, such as low-interest or interest-free loans. In such cases, a portion of the income or the benefit derived from the interest saved is attributed back to the donor’s income. 

When assets are donated to a trust, the full income earned by reason of the donation is attributed back to the donor and continues until the death of the donor. 

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Various scenarios trigger these rules: 

1. Low-Interest Loans: If a trust receives a loan from a donor at less than the official rate of interest (being the repo rate plus 100 basis points, per SARS Table 3), the income generated from the difference is deemed to be the donor’s income and taxed in his return of income accordingly. 
2. Direct Donations: When assets are directly donated to a trust, the full income generated from those assets is attributed to the donor for as long as the donor is alive. 
3. Asset Sale Below Market Value: If a trust acquires an asset from a donor below market value, the shortfall is considered a donation and the resulting income is attributed to the donor.

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Taxation under these rules varies: 

• Donor Taxation: The donor may be taxed on the attributed income, preventing the shifting of tax liability to the trust or beneficiaries. 
• Beneficiary Taxation: If the income is distributed or vested to beneficiaries,  they may be taxed instead, depending on the nature of the trust. 
• Trust Taxation: If the trust retains the income, it is taxed at a flat rate of 45%. 

The application of Section 7 is complex, requiring careful consideration of the trust’s  activities and the nature of transactions with donors. With SARS intensifying scrutiny on trusts, compliance with attribution rules is more critical than ever. Understanding  these rules is essential for trustees and donors / funders alike to navigate the tax implications of their actions within South African trusts.

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Join Cheryl Howard on the 18th of June where she will discuss everything related to "Application of Attribution Rules for Trusts"

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FAQs

1. What are the attribution rules for trusts in South Africa?

Attribution rules are anti-avoidance tax provisions that allow SARS to tax income, capital gains, or donations earned by a trust in the hands of another person, such as the founder, donor, or beneficiary, under specific circumstances.

2. Why does SARS apply attribution rules to trusts?

SARS applies attribution rules to prevent taxpayers from shifting income or assets into trusts to reduce their tax liability while still retaining control or benefiting indirectly from those assets.

3. When is trust income attributed back to the donor or founder?

Trust income may be attributed back when assets are transferred to a trust through a donation, loan, or other arrangement where the donor retains influence or benefits, particularly under sections 7 and 25B of the Income Tax Act.

4. Do attribution rules apply to capital gains in a trust?

Yes. Capital gains can be attributed to the donor or another connected person if the disposal of assets by the trust is linked to a gratuitous disposition or a loan with inadequate interest.

5. How do interest-free or low-interest loans trigger attribution rules?

Interest-free or low-interest loans to trusts may result in deemed donations and attribution of income or capital gains to the lender, especially where the loan enables the trust to generate taxable income.

6. Are beneficiaries affected by attribution rules?

Yes. In certain cases, income or capital gains distributed to beneficiaries may still be taxed in the hands of the donor or founder if attribution rules override the normal trust taxation principles.

7. Do attribution rules apply to offshore trusts?

Yes. Attribution rules can apply to offshore trusts where South African residents donate or transfer assets and retain control or benefit, subject to residency and controlled foreign trust considerations.

8. How do attribution rules interact with the conduit principle?

Attribution rules override the conduit principle. This means income cannot pass through the trust to beneficiaries for tax purposes if the law requires it to be taxed in another person’s hands.

9. Can proper trust structuring reduce the impact of attribution rules?

Yes. Careful planning, including arm’s-length loans, market-related interest, and genuine loss of control by the donor, can help reduce exposure, but professional tax advice is essential.

10. What happens if attribution rules are ignored or applied incorrectly?

Incorrect application may result in understatement penalties, interest, and additional tax assessments by SARS, making compliance and accurate disclosure critical for trust taxpayers.

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