Application of Attribution Rules for Trusts

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. 

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.

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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