In
ASA December 2024/January 2025 I considered the Constitutional Court's judgment in the matter of the
Thistle Trust v C: SARS. An issue that I did not consider in that article was the exact nature of the vested rights that the Thistle Trust held in the vesting trusts, mainly because I did not have any information on the nature of those rights. Strangely, neither the tax court, SCA nor constitutional court mentioned this fundamental issue. We can therefore only speculate on why Thistle did not raise it in its grounds of objection and appeal.
The facts of the Thistle Trust case were briefly that the Thistle Trust was a beneficiary of ten vesting trusts known loosely as the Zenprop Group. I shall refer to the vesting trusts in the singular for convenience. The vesting trust had disposed of immovable property, realised capital gains and vested those gains in Thistle which in turn sought to vest those amounts in its natural person beneficiaries. The Constitutional Court held that the gains had to be accounted for by Thistle under para 80(2) of the Eighth Schedule to the Income Tax Act 58 of 1962 as it was the beneficiary of the trust that disposed of the asset. The minority judgment held that the gain should be accounted for by the natural person beneficiaries of Thistle on the basis that the wording of para 80(2) was ambiguous.
It is thus now clear that a beneficiary can account for a capital gain of a trust only if it is a beneficiary of the trust that disposed of the asset and that beneficiary has, or acquires, a vested right to that capital gain. Since the 2014 to 2016 years of assessment with which Thistle was concerned, the wording of para 80(2) has been further clarified to remove the ambiguities referred to by the dissenting judges. For example, the words 'a trust beneficiary' have been replaced with 'a beneficiary of that trust' making it clear which trust is being referred to.
If Thistle had a vested right in the asset of the vesting trust, then the vesting trust would be acting as a pure administrator on behalf of Thistle, which would have been the beneficial owner of the asset, despite the asset being registered in the name of the vesting trust. Under these circumstances, Thistle would have been the trust that disposed of the asset and could then quite legitimately have attributed the capital gain to its natural person beneficiaries under para 80(2).
So, what might have prevented Thistle from having a vested right in the asset of the vesting trust?
In
Steyn v Steyn NO & others the court summarised the position of a trust as a debtor in insolvency as follows:
'A trust is recognised as a legal institution
sui generis. Despite being a legal entity, a trust does not possess legal personality and cannot sue or be sued in its own name. A trust litigates through its trustees.
'Despite not being a legal person, a trust falls within the definition of a debtor in section 2 of the Insolvency Act. This is because a trust is a special kind of entity that is empowered through its appointed trustees to acquire assets and credit as well as to incur debts. In other words, a trust through its trustees can owe creditors and be held accountable to pay incurred debts, failing which be vulnerable to being sequestrated when its liabilities exceed its assets.'
(Footnotes suppressed.)
Most vesting trust deeds in South Africa tend to contain a definition of 'trust capital' which refers to assets less liabilities. If there are liabilities in the trust, there would be a priority claim over the trust assets by the trust creditors. If the beneficiary had a vested right in the trust assets without being liable for the trust debts, the trust would be left in an insolvent position. Under those circumstances, the beneficiaries cannot be said to be unconditionally entitled to the trust assets. Their vested right relates to the amount remaining after settling the trust liabilities. Paragraph 80 refers to assets of a trust rather than trust capital, and this can make it quite difficult to determine whether a beneficiary trust has a vested right in the assets of the vesting trust.
The problem is that many vesting trust deeds were not drafted with para 80 in mind or might have been drafted before the introduction of capital gains tax on 1 October 2001.
One is then left with the difficult task of determining whether a beneficiary with a vested right in the trust capital does in fact have a vested right in the trust assets.
In
Natal Joint Municipal Pension Fund v Endumeni Municipality the court noted the following on legal interpretation:
'A sensible meaning is to be preferred to one that leads to insensible or unbusinesslike results or undermines the apparent purpose of the document.'
It surely would not be a sensible or businesslike result if the term 'trust capital' could never also mean trust assets in appropriate circumstances.
SARS notes in its
Comprehensive Guide to Capital Gains Tax (Issue 9) that one of the factors to be taken into account is whether the trustees have the power to borrow money, as this would tend to support an inference that the beneficiary does not have a vested right in the trust assets. It is submitted, however, that such a borrowing clause is not a decisive factor in determining whether a beneficiary has a vested right in a trust asset. Regard must also be had to the trust deed as a whole and the facts and circumstances of the case.
Assume a trust has three unbonded properties worth R60 million, a bank account of R2 million, debtors of R40 000 and accounts payable of R200 000. It is submitted that if the beneficiary trusts have vested rights in the trust capital, they probably have a vested right in the trust properties because no creditor has any claim over them, nor is likely to in the future.
Whether the beneficiary has a vested right in a trust asset should arguably be determined immediately before the asset is disposed of. If the trust in the above example had acquired the properties in 2005 using trust capital of R10 million and bonds of R50 million, and the properties are to be sold in 2025 by which time the bonds have been fully settled and not replaced with other debt, there would be no priority claim over the properties and there would be no reason why the beneficiaries would not have vested rights in the properties in 2025.
The trust deed may contain a clause requiring vested beneficiaries to stand surety for the trust debts or to advance monies to the trust in proportion to their vested rights when called upon to do so by the trustees. Such a clause is a strong indicator of the intention of the beneficiaries to protect their pre-existing vested rights in the trust assets.
The late Costa Divaris used to point out that many accountants do not give effect to the terms of the trust deed when drawing up annual financial statements for vesting trusts. He stated the following:
'I have yet to encounter an accountant who reads the deed before drawing a trust's annual financial statements. In fact, the true position is far worse: I have yet to encounter an accountant who registers what it means when, having read the deed myself, I declare the trust to be a so-called vesting trust.
So let me spell it out: it is only to the extent that a trust is (truly) discretionary that property may be reflected in the AFS as "trust property".'
Does such incorrect disclosure undermine the argument that the beneficiary trusts have vested rights in the trust assets?
In
Joffe & Co (Pty) Ltd v CIR it was stated that
'the Court is not concerned with deductions which may be considered proper from an accountant's point of view or from the point of view of a prudent trader, but merely with the deductions which are permissible according to the language of the statute'.
In
CIR v Genn & Co (Pty) Ltd the court noted the following on monies received by an agent or trustee:
'It certainly is not every obtaining of physical control over money or money's worth that constitutes a receipt for the purposes of these provisions. If, for instance, money is obtained and banked by someone as agent or trustee for another, the former has not received it as his income.'
Accounting disclosure is therefore not necessarily indicative of the correct tax treatment for purposes of para 80.
One can understand accountants drawing up trust financial statements which disclose trust assets that are registered in the name of the trust but beneficially owned by the beneficiaries, as the trustees need to know what assets are under their administration. Nevertheless, the accounts should disclose the basis on which they have been drawn up.
Sometimes trusts can be close to a partnership, and in one case the court declared a trust to be a partnership. That case was perhaps somewhat unusual as the trust deed did not have any named beneficiaries.
In ITC 1483, a case that concerned the 1986 year of assessment, the appellant sought to claim his share of a revenue loss incurred by a trust. The appellant was one of several beneficiaries of a trading trust that had acquired undeveloped land which it divided into 84 plots which were to be sold off at a profit. The scheme was a total failure, and all the participants lost their contributions. The court found in favour of the appellant and allowed him to claim the revenue loss.
The appellant argued that the trust had the characteristics of a partnership, though a partnership could not be formed as there were more than 20 participants. The trust deed provided that the beneficiaries 'shall share in the profits and losses relating to the property and shall contribute towards any monies required to pay the purchase price of the property'. It also provided that any beneficiary who failed to pay a contribution would be excluded from participation in the profits. The deed also stated that the profits vested in the beneficiaries pending distribution, the timing of the latter being at the trustees' discretion.
This case was heard before the introduction of s 25B, which contains specific rules in s 25B(4), (5) and (6) dealing with trust losses which are prevented from flowing to beneficiaries. However, whether those provisions apply in a situation in which beneficiaries contractually bind themselves to be liable for trust losses is doubtful. The position is closer to that of a bewind trust where the trust acts as a pure administrator on behalf of the beneficiaries who own the trust assets and accept liability for the trust debts.
In making amendments to a trust deed to ensure that it is in fact a fully vesting trust, caution needs to be exercised. If it turns out that the trust in question is not a fully vesting trust and the amendments to the trust deed make it a fully vesting trust, a disposal may be triggered under para 11(1)(d) of the Eighth Schedule, which may have adverse CGT consequences.
One strategy sometimes employed to address the problem of a capital gain not being able to flow through a multi-tier structure is to make the natural person beneficiaries of the second trust, beneficiaries of the first trust. This strategy may work when the first trust in the chain is a discretionary trust, but one must guard against changing the purpose of a trust by appointing new contingent beneficiaries as this can cause a new trust to come into existence.
However, with a vesting trust, adverse CGT consequences can result as the beneficiary trust would have to dispose of part of its vested right to the natural person beneficiaries.
Conclusion
In conclusion
- When a vesting trust is part of a multi-tier trust structure with discretionary trust beneficiaries, its trust deed should ensure that the trust beneficiaries have vested rights (beneficial ownership) in its assets rather than in the amount remaining after deducting any trust liabilities. Having such rights will enable the discretionary trusts to on-distribute any capital gains to their resident beneficiaries under para 80(2);
- in some trust deeds, a vested right in trust capital may be the equivalent of having a vested right in trust assets, but making this assessment may not always be easy; and
- caution must be exercised when amending a vesting trust deed to ensure that it does not trigger a disposal of the trust assets for CGT purposes.
This article was first published by ASA in its
May 2025 issue.
