Capital Gains Tax
1951. Trusts conduit pipe principle
May 2011 - Issue 141
Rene Magritte (1898 - 1967), the Belgian Surrealist artist, painted a smoking pipe and below it the words "Ceci n’est pas une pipe", (This is not a pipe.) And, of course, the painting of the pipe isn’t a pipe; it is an image of a pipe.
In South African tax law (which may also seem surreal at times) there is the common law principle of a conduit pipe. The principle is that the trustee of a trust is a conduit in certain circumstances. For instance, if a company declares a dividend in respect of shares held by a trust, and the trustees promptly distribute the dividend to the beneficiaries, the dividend retains its nature in the hands of the beneficiaries (see Secretary for Inland Revenue v Rosen ( (32 SATC 249)).
As far as income tax is concerned, the conduit pipe principle has to an extent been codified in section 25B of the Income Tax Act No. 58 1962 (the Act.
The question arises whether it also applies to capital gains tax (CGT).
For example, Sigmund and Salvador are beneficiaries of a trust formed in South Africa (SA) by their late father. Sigmund is tax resident in SA. Salvador is tax resident in Spain.
The trustees sell some shares listed in South Africa that were held as a long-term investment. The trustees promptly vest the profit in Sigmund and Salvador.
Paragraph 80(2) of the Eighth Schedule to the Act says that, if a trust makes a capital gain and vests that gain in a trust beneficiary that is tax resident in South Africa, the gain is subject to CGT in the hands of the beneficiary, and not in the hands of the trust.
Often, the application of that provision results in a lower effective tax rate: the effective CGT rate of a trust is 20%; the effective CGT rate of a natural person varies between 0% and 10%.
CGT was introduced in South Africa in 2001. Since that time, many people assumed that, because of the wording of paragraph 80(2), if a trustee distributed a capital gain arising on the disposal of an asset by a trust to a beneficiary that was not tax resident in South Africa, the capital gain would in all cases be subject to CGT in the hands of the trust.
So if we applied paragraph 80(2) to the example above, Sigmund would pay CGT on the capital gain distributed to him while the trust would pay CGT on the capital gain distributed to Salvador, because he is not tax resident in South Africa.
Some commentators say this is all wrong. They say that paragraph 80(2) simply codifies the common law conduit principle in relation to South Africa tax residents; it does not alter the principle generally or in relation to beneficiaries that are not tax residents in particular (see, for instance, the authorities listed in the South African Revenue Services (SARS) Comprehensive Guide to Capital Gains Tax (Issue3) at page 443).
If this position is correct, then Salvador, in our example above, will, in fact, pay no CGT in
South Africa when the trustees distribute the capital gain to him. Generally, persons who are not tax resident in South Africa only pay CGT in South Africa in respect of the disposal of immovable property in South Africa and assets of a permanent establishment in South Africa.
Not surprisingly, SARS sees the matter differently. SARS says that the conduit principle does not apply where a trust distributes a gain to a non-resident beneficiary mainly because the "legislative intent" in respect of paragraph 80(2) was to limit the conduit principle to resident beneficiaries
(see page 443 of the Guide).
So does the pipe exist or not? Does the conduit pipe principle apply where a trust distributes a capital gain to a non-resident beneficiary?
Unfortunately, there is no clear answer to this question. We will need to await the courts or legislature to guide us. In the meantime, trustees should take advice before they make capital distributions to non-resident beneficiaries.
Editorial comment: Experts are still divided on this issue. It is indeed a pity that this aspect has not been clarified by the legislature.
Cliffe Dekker Hofmeyr
IT Act:8th Schedule: par 80(2)
SARS Comprehensive Guide to Capital Gains Tax (Issue3)