On 28 April 2016 the Davis Tax Committee released its final report on estate duty. The report made some observations about the 'attribution back to donor' rules in the Income Tax Act 58 of 1962 (the Act), which highlighted an estate duty minimisation opportunity. References in this article to sections are to sections of the Act and to paragraphs are to paragraphs of the Eighth Schedule to the Act.
The two 'attribution back to donor' provisions that are relevant to this article are s 7(5) and para 70.
Section 7(5) provides as follows:
'(5)
If any person has made any donation, settlement or other disposition which is subject to a stipulation or condition, whether made or imposed by such person or anybody else, to the effect that the beneficiaries thereof or some of them shall not receive the income or some portion of the income thereunder until the happening of some event, whether fixed or contingent, so much of any income as would, but for such stipulation or condition, in consequence of the donation, settlement or other disposition be received by or accrue to or in favour of the beneficiaries, shall, until the happening of that event or the death of that person, whichever first takes place, be deemed to be the income of that person.'
The equivalent capital gains tax (CGT) provision is para 70, which provides as follows:
'70. Attribution of capital gain subject to conditional vesting.—Where—
(a)
a person has made a donation, settlement or other disposition that is subject to a stipulation or condition imposed by that person or anyone else in terms of which a capital gain or a portion of any capital gain attributable to that donation, settlement or other disposition shall not vest in the beneficiaries of that donation, settlement or other disposition or some of those beneficiaries until the happening of some fixed or contingent event;
(b)
a capital gain that is attributable to that donation, settlement or other disposition has arisen during a year of assessment throughout which the person who made that donation, settlement or other disposition has been a resident; and
(c)
that capital gain or a portion thereof has not vested during that year in any beneficiary who is a resident,
that capital gain or that portion thereof must be taken into account in determining the aggregate capital gain or aggregate capital loss of the person who made that donation, settlement or other disposition and disregarded when determining the aggregate capital gain or aggregate capital loss of any other person.'
Section 7(5) has been the subject of several tax cases, which have clarified its interpretation. These principles also apply to para 70.
In Ovenstone v SIR the court held that the phrase 'donation, settlement or other disposition' covered disposals of property made wholly gratuitously out of liberality or generosity ('donation') and for some consideration but in which there is an appreciable element of gratuitousness and liberality or generosity ('settlement or other disposition'). It, however, excludes any disposal of property made for due consideration wholly for commercial or business reasons. When the disposal is funded partly gratuitously and partly for consideration (for example, by way of a low-interest loan), apportionment may be appropriate. In determining the rate of interest that should be charged on a loan, regard must be had to what the trust would have paid had it borrowed the funds on normal commercial terms. The rate that the donor would have paid is irrelevant.
In CIR v Berold the court held that the foregoing of interest on a loan amounted to a continuing donation.
In C: SARS v Woulidge, a case involving the disposal of assets to a trust on loan account, the court held that the loan itself was not a donation as it represented due consideration for the sale. The court also confirmed that the in duplum rule under which the interest may not exceed 100% of the loan did not apply to s 7. This principle has since been codified in s 7D, which also states that interest must be determined as simple interest calculated daily.
In deciding whether income is attributable to a donation, settlement or other disposition, the principle established in CIR v Widan must be applied. In other words, there must be some close causal relation between the income or capital gain and the donation. In determining this connection, regard must be had to the real efficient cause of the income being generated.
As to whether the exercise by the trustees of their discretion is a 'fixed or contingent event' — an issue debated for years — the position was aptly summed up in my view in ITC 1033 by Herbstein J when he stated the following:
'The word "event" is one of wide significance and its ambit is increased by the addition of the words "whether fixed or contingent". In principle there does not appear to be any reason why the exercise by the trustees of a discretionary power should not be "an event", which according to the Oxford Dictionary is "the fact of a thing's happening" or a "thing that happens". There is nothing in the subsection which would justify the court in cutting down the generality of this meaning.'
In practice, SARS accepts that the exercise of a trustee's discretion is an event for the purposes of s 7(5) and para 70.
Section 7(5) and para 70 cannot be applied once a donor is deceased.
When the donor funds an asset by donation, there will be no limit on how much of the income or capital gain generated by the asset can be deemed back to the donor. But when the asset is funded by a low or interest-free loan, the amount that can be deemed back to donor is limited to the failure to charge interest at an arm's length rate. For example, if the donor lends R1 million to the trust interest free and the trust would have paid 10% a year had it borrowed the funds from a third party, the amount of income or capital gain that can be deemed back for the year of assessment would be limited to R100 000. If the donor charged the trust 6%, the amount that can be deemed back to the donor would be R40 000. When both income and a capital gain are involved, it will be necessary to determine the amount available to deem the capital gain back to the donor on a cumulative annual basis, excluding any income deemed back under s 7(5). For example, if the loan of R1 million was interest free, income of R70 000 was derived from the asset each year and the asset is sold at a capital gain of R500 000 after 10 years, then R30 000 × 10 = R300 000 of the capital gain could be deemed back to the donor under para 70. The excess of R200 000 would be taxable in the trust or it could be vested in a resident beneficiary in the tax year of disposal under para 80(2).
As noted by the Davis Tax Committee, s 7(5) used to be an anti-avoidance provision aimed at preventing the use of trusts for income splitting. Before years of assessment commencing on or after 1 March 1998, trusts were taxed on a sliding scale with the same maximum marginal rate as individuals, but without the rebates. In those years marginal tax rates were eye-wateringly high. For example, in 1972 the maximum marginal rate of tax for an individual was 66% (inclusive of a surcharge), plus a loan levy of 12% which increased the rate to 78%. In the 1999 to 2002 years of assessment, trusts were taxed at a dual rate of tax. In the 1999 year of assessment, the first R100 000 of taxable income was taxed at 35% and above that level at 45%, the latter being equal to the maximum marginal rate of an individual. Both the sliding scale and the dual rate for trusts offered income-splitting opportunities by using pour-over trusts. Thus, when Trust 1's taxable income reached a certain marginal rate, it would distribute its excess taxable income to Trust 2 and so on. Seen in this light s 7(5) made perfect sense by deeming the income back to the donor who was taxable at a high marginal rate.
However, from 1 March 2002 trusts have had a flat rate of tax equal to the maximum marginal rate of individuals (currently 45%), while capital gains are taxed at a maximum of 36% (80% inclusion rate × 45% flat rate). Therefore, income deemed back to a donor under s 7(5) would be taxable at 0% to 45% and capital gains at a rate of 0% to 18% (40% inclusion rate × 45% maximum marginal rate) depending on the level of taxable income of the donor. So, far from being an anti-avoidance measure, deeming income and capital gains back to a donor under s 7(5) or para 70 may well result in the amounts being taxed at a lower rate than the trust.
Of course, a similar income tax or CGT result could be achieved by vesting the income or capital gain in a resident natural person beneficiary under s 25B(1) or para 80(2), but such vesting will have adverse estate duty consequences for the beneficiary whose estate will be increased in value by the vested amount. By contrast, the amount deemed back to a donor under s 7(5) or a capital gain under para 70 is simply a tax fiction and does not increase any property in the donor's hands. In addition, the donor is liable for the income tax or CGT which has the effect of reducing the donor's estate by the amount of the tax paid. The donor is given a right to recover the tax from the trust under s 91(4) (tax on income) and (4A) (CGT) but is not obliged to exercise it. Not recovering the tax from the trust will reduce the donor's estate for estate duty purposes.
The income or capital gain retained in the trust can be allowed to grow in value in the trust or can be distributed in future years of assessment to resident or non-resident beneficiaries tax free. This tax-free treatment arises from the fact that the amount is neither income dealt with in s 25B, nor a capital gain under para 80. In Estate Dempers v SIR Corbett JA (as he then was) commented on this issue in a provision equivalent to s 7(5) when he stated the following:
'The answer to this contention is that once this income has been deemed under s 9(5) to be that of the donor, it is so deemed for all time and there is no room for any finding that subsequently it accrued to the donee as income.'
The tax-free amount should not be vested in a resident beneficiary in the year of assessment in which it arises to avoid it being characterised as income or a capital gain under s 25B or para 80.
Example — Application of para 70
Facts:
Jack formed the Jack Family Trust (a discretionary trust) in 2005 with a founding donation of R5 000. The donation took the form of an executory contract of donation (a written promise to pay). Shortly afterwards, he subscribed for 5 000 shares in Newco (Pty) Ltd (Newco) of R1 each on behalf of the trust and his debit loan account in the trust was replaced with the shares in Newco. The beneficiaries of the trust are Jack's wife and his son and daughter. Newco's business turned out to be extremely profitable and during the 2025 year of assessment the trust sold the shares to a listed company for cash of R201 million giving rise to a capital gain of R200 million after various legal fees were added to base cost under para 20(1)(c)(i).
The trustees resolved not to vest the capital gain in any beneficiary. Jack is on the maximum marginal rate of 45%. The annual exclusion was used against other capital gains during the 2025 tax year. Jack did not exercise any right of recovery of the CGT against the trust under s 91(4A). When Jack eventually dies, assume that the net value of his estate for estate duty purposes is at least R30 million.
Result:
Jack must account for the capital gain of R200 million in his 2025 return of income on which CGT of R36 million will be payable (R200 million × 40% inclusion rate × 45% marginal rate).
The value of Jack's estate for estate duty purposes will be reduced by R36 million. This reduction will result in an estate duty saving of R9 million (R36 million × 25% maximum estate duty rate).
The trust will be free to invest the R200 million net proceeds from the sale of the shares in other growth assets. It could also vest this after-tax capital in its beneficiaries tax free in the 2026 and subsequent years of assessment.
This article was first published by ASA in its
October 2025 issue.
