Can the conduit principle be used in structures where there are multiple trusts? This issue has recently been heard by the Constitutional Court in the case of Thistle Trust v Commissioner for the South African Revenue Service (CCT 337/22) [2024] ZACC 19 which has guided how to tax capital gains in multi-tiered trust structures.

Trusts have a firm foundation in South African law. They are created where property or assets are transferred by a person (the founder) in favour of others (the beneficiaries). The property and assets are placed under the control of trustees who manage and administer the trust for the benefit of the beneficiaries. Trusts offer various benefits such as asset protection, tax planning, and continuity of wealth across generations, but trusts have their own rules in respect of taxation. 

South African trusts are subject to what is known as the conduit principle. The conduit principle allows income or capital gains received by a trust in a year of assessment to "flow through" or be distributed to its beneficiaries. If this distribution to the beneficiaries is done in the year of assessment as the income or capital gains are received or accrued by the trust, then the income and capital gains tax is taxable in the hands of the beneficiaries at their individual tax rates rather than the higher tax rates applicable to trusts. Naturally, the conduit principle can be strategically utilised to reduce the tax burden in trusts. 

But can the conduit principle be used in structures where there are multiple trusts? 

Paragraph 80 of the Eighth Schedule of the Income Tax Act 58 of 1962 deals with attributions of capital gains by a trust to its beneficiaries. In terms of paragraph 80, where a trust distributes an asset to a beneficiary who is a South African resident, then the gain realised on that asset will be taxable in the hands of the beneficiary. Additionally, where a trust disposes of an asset and vests the gains in the hands of the beneficiary in the same year of assessment, then the gains will also be taxable in the hands of the beneficiary.

An exception to this rule is where a trust vests capital gain to another trust. In such situations, the second trust cannot vest the gains to its beneficiaries and apply paragraph 80 as the second trust is considered not to have disposed of the asset, nor did it realise a capital gain.

In the Thistle case, the Thistle Trust received capital gains from a vesting trust of which the Thistle Trust was a beneficiary. The Thistle Trust in turn vested the capital gains to its beneficiaries, who declared the gains in their tax returns, and not in the returns of the Thistle Trust. SARS, however, assessed the Thistle Trust on the basis that the Thistle Trust was liable for the capital gains and not the beneficiaries (seeing that the Thistle Trust could not apply paragraph 80 to the subsequent distribution of the gains). 

The Thistle case ultimately ended up in the Constitutional Court, where the court found that paragraph 80 was the applicable provision to determine the tax liability for a capital gain. The court interpreted the purpose of paragraph 80 “to prevent the conduit principle from operating in relation to capital gains beyond the first beneficiary trust in a multi-tiered trust structure” ultimately confirming that it was the Thistle Trust, and not its beneficiaries, that had the tax liability. 

Considering the above, it is pertinent that a trust deed is formulated in accordance with the purpose for which the trust was created to ensure tax efficiency. Just because a trust may benefit from the conduit principle, it does not automatically mean that the principle will always be applicable. It is vital that you consult a professional trust or tax specialist to make sure that your trust is formulated most effectively given the purpose of your trust and you avoid unforeseen tax consequences.


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