1929. Capital distributions from trusts
In a judgment handed down on 29 November 2010 , the Supreme Court of Appeal (SCA) overturned a
2009 decision of the tax court regarding an assessment for donations tax of some ZAR78 million plus
interest of ZAR94 million. The court found in The Abraham Krok Trust v CSARS 58/10 
ZASCA 153 (not yet reported in the tax reports) that the trustees had acted within their powers in
awarding assets in the form of loan accounts to other trusts for the benefit of beneficiaries.
The appellant, a family trust and referred to in this article as the Krok Trust, had been in existence
since 1973. Six beneficiaries were nominated, these being the children of the donor. In 1981, the trust
deed was substituted by a new deed in terms of which the assets of the taxpayer were divided into six
equal trusts, one for the benefit of each child. These were called the “sub-trusts” and the trust deeds
of each stipulated that the terms of the Krok Trust would apply to them.
In 1994, another six trusts were created, one for each child, called the “1994 children’s trusts”. The
trustees of each of the sub-trusts then entered into a sale agreement with its counterpart 1994
children’s trust in terms of which they sold capital assets to the 1994 children’s trust at market value.
The net result was that each 1994 children’s trust owed its counterpart sub-trust some ZAR52 million.
In 1997 the trustees of the Krok Trust (the collective name under which the sub-trusts were
administered) decided retrospectively to 1996 to award to each of the 1994 children’s trusts an amount
equal to the balance owing. The awards were made by set-off against the loan accounts.
The Commissioner for SARS imposed donations tax on the awards on the grounds that the awards had
not been made “under and in pursuance of a trust” as contemplated in the exemption provisions for
donations tax, in that the 1994 children’s trusts were not beneficiaries of the sub-trusts – the respective
children were. The trustees were of the view that section 56(1)(l) of the Income Tax Act No. 58 of
1962 (the Act), did indeed provide just that exemption.
While the matter was still in dispute, the trustees received Counsel’s opinion that the awards to the
1994 children’s trusts might have been ultra vires, on the grounds that, because these trusts were not
beneficiaries of the respective sub-trusts, the trustees did not have the power to make awards to them.
The trustees decided not to act in terms of the advice and reinstate the loans as assets of the taxpayer
and liabilities of the 1994 children’s trusts, but rather to await the outcome of the appeal, using the
alleged invalidity and recourse to section 56(1)(l) as alternative arguments in their favour.
Although section 56(1)(l) of the Act exempts from donations tax any donation made “under and in
pursuance of a trust”, this exemption applies only to donations to the beneficiaries. The reason for
the exemption is that donations tax will already have been paid on the donation of the assets to the
trustees. If the trustees make donations to persons other than the beneficiaries, however, these are not
covered by the exemption.
SARS took the view that, because the 1994 children’s trusts were not beneficiaries of the sub-trusts,
the awards were donations subject to donations tax.
In the tax court, the Krok Trust raised several arguments, which may be summarised into two
• firstly, that the trustees had never intended to waive or renounce the debts, and their inaction
pending the outcome of the court case should not be so construed;
• secondly, that if the awards were invalid, then they were a nullity and no property could have been
disposed of pursuant to them, and the set-off ought never to have taken place.
The tax court found that the conduct of the trustees, once they were aware of Counsel’s view, in not
reinstating the loans, was evidence that they intended the awards to take place. As for the effects of
the invalidity, the court referred to MP Finance Group CC (in liquidation) v CSARS  (69 SATC
141) where the SCA found that the validity of a transaction is irrelevant insofar as its liability for
income tax is concerned. There was no reason, according to the court, why a void transaction should
not also give rise to a donations tax liability.
In the SCA the court suggested obiter that the validity or otherwise of such a transaction would not
affect the application of the donations tax provisions, but decided that it was not necessary to pursue
that leg of the enquiry. The court assumed in favour of the Commissioner that an unauthorised
donation would attract donations tax and then proceeded to consider whether the donations had been
made in terms of the trust deed and that therefore the section 56(1)(l) exemption applied. Central to
this decision were two clauses of the trust deed: clause 11.1 provided that the income of the trust
should be applied in such amounts and in such manner as the trustees might in their discretion
determine for the benefit of the children and for their maintenance, well being, education, upbringing
and reasonable pleasures; clause 12.1 empowered the trustees in their discretion to apply any portion
of the capital of the trusts towards the purposes set out in clause 11.1. The court found that this was
what the trustees had done, that the relevant clauses provided for this, and that therefore the awards
had been made under and in pursuance of the trusts. Consequently the appeal succeeded on the basis
that the section 56(1)(l) exemption applied.
It would be interesting to know what the court would have decided had it come to the opposite
conclusion. Firstly, would it have made its obiter remark a firm finding and decided that the
unauthorised nature of the awards did not affect their validity, as seems to have been the suggestion?
Secondly, if each 1994 children’s trust had had a class of beneficiaries extending beyond those of the
sub-trusts, might this have rendered the transactions invalid and not under and in pursuance of the
trusts? In this matter the beneficiary of each 1994 children’s trust was the same person as its
counterpart sub-trust. We cannot be certain, but what is certain is that this matter would probably
never have come to court had the trustees taken the precaution of nominating each of the 1994
children’s trusts as a beneficiary of its counterpart sub-trust. Here lies a lesson for all trustees.
Editorial Comment: Where trustees act outside the ambit of the trust deed, they may also be held
personally liable for breaching fiduciary duty.
IT Act: s 56(1)(l)