By Sarah Simson | Consultant Attorney
South Africa’s recent amendment to section 25B of the Income Tax Act introduces a material change in the taxation of income distributed by resident trusts to non-resident beneficiaries. While positioned as a clarification, the change marks a significant departure from the prior position and introduces complexity and potential double taxation concerns for cross-border estate and fiduciary planning.
Effective from 01 March 2024, the Taxation Laws Amendment Act 17 of 2023 narrows the application of the long-established conduit principle with respect to income and aligns the treatment of income distributions to non-residents with the approach already followed for capital gains under paragraph 80 of the Eighth Schedule.
For years, the tax treatment of capital gains and income distributed by trusts to non-resident beneficiaries diverged. In terms of paragraph 80 of the Eighth Schedule, where a capital gain is vested in a resident beneficiary, the gain is attributed to that person and excluded from the trust’s tax calculation. However, where a capital gain is vested in a non-resident, the gain is taxed in the trust’s hands at the trust’s flat rate of 36%. This treatment has long been understood and accepted, albeit disadvantageous for foreign beneficiaries who might otherwise have faced a maximum effective CGT rate of 18% had the gain accrued to them directly.
In contrast, section 25B previously allowed income (not capital gains) to flow through a trust to any beneficiary, resident or non-resident, provided the vesting occurred in the same year of assessment. This effectively rendered South African trusts tax-neutral flow-through vehicles, especially in respect of foreign-source income distributed to offshore beneficiaries.
The 2023 amendment to section 25B now confines the conduit principle only to resident beneficiaries. Income will now be deemed to accrue to a beneficiary only if that beneficiary is South African tax resident and has a vested right to the amount. In all other cases — including where the income vests in a non-resident the income is now taxable in the trust, at the standard trust income tax rate of 45%.
This development effectively aligns the treatment of income with the existing treatment of capital gains for non-resident beneficiaries, but it introduces significant changes for those who previously relied on the conduit principle to minimise tax leakage through South African resident trusts.
If an amount is later paid to the non-resident beneficiary, no further South African income tax arises. However, the initial trust-level taxation cannot be avoided, and planning for foreign beneficiaries must now accommodate this flat-rate exposure.
It is important to note that where section 7 attribution tax rules are applied, for example where the trust has been funded by way of donation, then the funder will be taxed, and the trust will not be taxed. This is a valuable planning opportunity in the mechanism of how a trust is funded.
It is worth noting that clarity on the rules that apply to vested trusts where a beneficiary has vested rights to trust assets, awaits a proposed amendment as per National Treasury’s 01 November 2023 Tax Laws Amendment Bill.
It is arguable that where a vested right exists, the trustee merely acts as an agent of the beneficiary. In such cases, taxing the trust may conflict with the underlying principle of agency.
However, in the absence of further legislative guidance or interpretive notes, trustees should proceed on the assumption that both discretionary and vesting arrangements may be caught by the revised legislation.
A key concern is that the trust may now be treated as the beneficial owner of income (e.g. dividends or interest), rather than merely acting as a conduit. Prior to the amendment, non-resident beneficiaries could often invoke Double Tax Agreements (DTAs) to access reduced withholding tax rates, provided they were considered the beneficial owners of the income.
If the trust is now seen as the beneficial owner due to the deeming rules in the amended section 25B, treaty relief may be denied to the beneficiary. This creates a dual exposure: (1) a 45% tax paid by the trust in South Africa, and (2) potential tax in the beneficiary’s country of residence, with no foreign tax credit available.
While the recent amendment deals specifically with income, the Constitutional Court’s judgment in Thistle Trust v SARS (2 October 2024) delivered a decisive blow to efforts to use the common law conduit principle to stream capital gains through multiple-tiered trust structures. The Court held that specific provisions of the Income Tax Act override the common law, and that gains must be taxed in the distributing trust unless express statutory flow-through is permitted.
Although Thistle concerned capital gains, the judgment reinforces a strict legislative interpretation, which may similarly shape how the amended section 25B is applied.
Section 25B will invalidate the ability of non-resident beneficiaries to utilise carried-forward deductions or allowances under section 25B(6), since no income is now deemed to accrue to them. This may affect the long-term tax efficiency of legacy trust structures with complex deduction histories.
In addition, if the non-resident’s home country taxes on a residence basis, the beneficiary may be taxed again on amounts already taxed in South Africa without receiving a tax credit. The risk of economic double taxation is real and underscores the need for thorough cross-border planning.
While technically a targeted amendment, the revision to section 25B fundamentally alters the planning landscape for South African resident trusts with non-resident beneficiaries. The change extends the long-standing higher-tax treatment of capital gains to now include income distributions, bringing both under the same restrictive umbrella.
Together with Thistle Trust, the amendment sends a clear message: the conduit principle is no longer a reliable strategy in international trust planning. Trustees, advisors, and families must now urgently revisit their structures to prevent adverse tax outcomes - especially where legacy trusts include foreign heirs or offshore spouses.
