Thistle Trust v Commissioner for the South African Revenue Service (CC) (unreported case no CCT 337/22, 2-10-2024) (Bilchitz AJ, Chaskalson AJ, Madlanga J, Majiedt J, Mathopo J, Mhlantla J, Theron J and Tshiqi J)In the judgment handed down on 2 October 2024, the Constitutional Court (CC) addressed how the conduit principle applies to the taxation of capital gains distributed to beneficiaries through multiple trusts in a tiered trust structure (para 2).
The common law conduit principle treats income of a particular nature that is distributed on a discretionary basis from a trust to a natural person as taxable in the hands of the natural person, not the trust. As such, where capital gains realised from the sale of an asset by a trust is distributed to the beneficiaries in the same tax year, are taxed in the hands of the beneficiaries (para 119 and 42). The CC held that the principle has since been codified in the Income Tax Act 129 of 1991 (para 46). Through para 80(2) of sch 8, the Income Tax Act 58 of 1962 (ITA) has incorporated the common law conduit principle as it relates to capital gains tax. The judgment, therefore, focused on para 80(2) that governs how the conduit principle is to be applied to establish where tax liability lies for capital gains realised by the sale of assets by a trust (para 55 and 121).
Finding in favour of the South African Revenue Service (Sars), the appeal was dismissed in a divided judgment with Bilchitz AJ dissenting.
Thistle is an inter vivos trust and a beneficiary of the Zenprop Group. Between the 2014 – 2016 tax years, Zenprop disposed of assets and realised capital gains, which it then distributed to Thistle. Thistle, in turn, distributed the proceeds of those capital gains to the natural persons who were its beneficiaries. Thistle did not account for the capital gains in their tax returns for these years, taking the position that tax liability lay with the ultimate beneficiaries (para 6).
Sars disagreed, stating that as the direct beneficiary of Zenprop, Thistle was liable for capital gains tax (para 8).
Thistle approached the Tax Court where it argued that s 25B of the Income Tax Act, as it was between 2014 – 2016, reads: ‘Any amount received by or accrued … shall … be deemed to be an amount which has accrued to that beneficiary’ (my italics). Thistle argued that the wide and unqualified meaning ‘any amount’ can be interpreted to include capital gains it received from Zenprop (para 13).
The Tax Court accepted this interpretation, finding that the capital gains were not taxable in the hands of Thistle, but were taxable as capital gains in the hands of its beneficiaries (para 13).
Section 28 of the Taxation Laws Amendment Act 23 of 2020 amended s 25B of the ITA. The amended provision now reads:
‘Any amount (other than an amount of a capital nature … ) … shall … be deemed to be an amount which has accrued to that beneficiary, and to the extent to which that amount is not so derived, be deemed to be an amount which has accrued to that trust.’
This case, however, concerned tax disputes arising in the tax years 2014 – 2016, and thus raises an issue of retrospectivity. A court cannot apply the 2020 amendment to tax disputes which concerned years 2014 – 2016, neither could the court use the amendment to retrospectively inform the proper interpretation of s 25B pertinent to this case (para 13).
The Tax Court decision was overturned by the Supreme Court of Appeal who accepted Sars’ argument that the capital gains realised by the disposal of properties by Zenprop were taxable in the hands of Thistle and not in the hands of the ultimate beneficiaries. This, so it held, flowed from the fact that Thistle had not itself disposed of any capital asset or determined any capital gain. Thistle had only distributed moneys that vested in it from Zenprop as of right and in these circumstances the conduit principle did not apply in terms of para 80(2) (para 17).
With two competing decisions, the Constitutional Court (CC) held that the interests of justice required that leave to appeal to be granted (para 36).
The CC placed specific focus on the 2008 amendment that changed the introductory wording of para 80(2) from ‘where a capital gain arises in a trust’ to ‘where a capital gain is determined in respect of the disposal of an asset by a trust’ (para 62). It was this wording that proved determinative. Applied to the facts of this case – it was Zenprop who disposed of the asset, not Thistle (para 58). Thus, the CC concluded that:
‘The wording of paragraph 80(2) shows that the provision applies the conduit principle only to the first beneficiary trust in a multi-tiered trust structure. It is not reasonably possible to interpret paragraph 80(2) to allow the conduit principle to run through a multi-tiered trust structure to attribute liability for capital gains tax in respect of the disposal of an asset to a beneficiary beyond the first beneficiary of the trust that realised the capital gain by disposing of that asset’ (para 69).
Sars argued that Thistle was aware of Sars’ stated position and chose to ignore it – so understatement penalties were warranted. The CC invoked its previous position about unilateral authority of Sars, stating that:
‘This argument is based on the proposition that no taxpayer can act reasonably on advice that differs from Sars’ statements of its interpretation of tax legislation. The argument would elevate Sars to the status of an authority that can decree the only reasonable interpretations of tax legislation. It is an untenable argument’ (para 89).
This reaffirms the CC view held in Marshall NO and Others v Commissioner, South African Revenue Service 2019 (6) SA 246 (CC). The CC found that because the Tax Court had upheld the tax position taken by Thistle, such cannot be said to be a tax position based on no reasonable grounds to take, even if the CC found this position to be incorrect and the appeal dismissed (Thistle Trust at para 88).
For this reason, in addition to the expressed unease of the CC having to sit as a court of first instance on this issue, Sars’ counterapplication for understatement penalties was refused.
The dissenting judgment agreed with the majority that in the context of capital gains tax, para 80(2) is the applicable provision to determine in whose hands a capital gain must be taxed (para 111). Where Bilchitz AJ takes issue is the application of the conduit principle in the context of multi-tier trust structures (para 122), arguing that there is significant ambiguity in how para 80(2) relates to multi-tier trust structures (para 112). Bilchitz AJ argued that there is no attempt to explain why the conduit should be blocked in relation to capital gains but not in relation to dividends or interest (para 129).
‘It is common cause, applies the conduit principle to all other forms of income throughout a multi-tier trust structure. If we are to construe the provisions of the Income Tax Act harmoniously, it would seem that section 25B and paragraph 80(2) should be interpreted to reinforce one another, rather than as enshrining different approaches to the conduit principle in the same statutory scheme’ (para 132).
Kate Dent LLB LLM (cum laude) (Unisa) PhD Public Law (UCT) is a legal researcher and author of Lawfare and Judicial Legitimacy (Oxfordshire: Routledge 2024) in Pietermaritzburg.
This article was first published in De Rebus in 2024 (December) DR 44.
