Navigating Tax Consequences for Family Trusts: Interest, Withdrawals, and Beneficiary Buy-Outs

Navigating Tax Consequences for Family Trusts: Interest, Withdrawals, and Beneficiary Buy-Outs

• 18 June 2025
• Administration of Estates
• The Tax Faculty Tax Specialist

This article is based on tax law for the year ending 29 February 2026.

Question:

A family trust has distributed income and capital to beneficiaries, including trustee members. After formation, some trustees made withdrawals; one trustee/beneficiary wishes to exit, and must be bought out by others using personal funds. Interest is generated by a trust investment account. The founder is now deceased and several years of trust tax returns remain outstanding. The key tax questions relate to the correct declaration and taxation of interest income, withdrawals/distributions to beneficiaries/trustees, the buy-out of a trust interest, and compliance with filing requirements.

Answer:

The Problem / Facts

A South African family trust has distributed both income and capital to beneficiaries, including trustees. After establishing the trust, certain trustees withdrew funds, and now one trustee–beneficiary intends to exit and be bought out by the remaining trustees using their own resources. The trust has earned interest on an investment account. Following the death of the founder, several years of tax returns remain outstanding. The primary tax questions are: how to correctly declare and tax interest income; how withdrawals or distributions to beneficiaries and trustees should be treated; whether a buy-out of a trust interest triggers taxable income or capital gains; and how to ensure compliance with SARS filing requirements.

Legal Analysis

Interest Income

The trust must declare any interest earned in its annual tax return, unless the trustees formally resolved to distribute or vest that interest to specific beneficiaries during the assessment period. If such a resolution was made before year-end, the beneficiary(ies) to whom the interest is vested must declare and pay tax on it in their personal returns. (ITA ss 25B, 7)

Distributions & Withdrawals

Any distributions of income clearly vested or transferred to beneficiaries or trustees are taxable in the hands of the recipient under section 25B. In contrast, withdrawals of capital may trigger a capital gains tax (CGT) event if they constitute a disposal of a capital asset. (ITA s 25B; Eighth Schedule)

Buy-Out of Trustee–Beneficiary

If the buy-out involves the sale of a vested interest in the trust’s capital, it is treated as a capital gains event under the Eighth Schedule, and the departing trustee–beneficiary must account for CGT on any gain realised. Discretionary trust interests and their sale are more complex; in certain cases, the legal concept of repudiation may affect the outcome. (Eighth Schedule to ITA)

Outstanding SARS Returns and Penalties

The trust must submit all outstanding tax returns without further delay. Failure to do so may trigger penalties under section 210 of the TAA. SARS may also impose interest and administrative penalties in terms of sections 25–26 of the TAA and section 66 of the ITA. Prompt regularisation of returns is essential. (ITA s 66; TAA ss 25, 26, 210)

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