SOME US/SA TRUST TAX ISSUES FOR SA TRUSTEES

Transcription

1 1 SOME US/SA TRUST TAX ISSUES FOR SA TRUSTEES Presentatin t STEP Suth Africa Cnference 2012 by Prfessr Michael Hniball Partner, Webber Wentzel 29 May 2012 Webber Wentzel 2012

2 2 Sme US/SA Trust Tax Issues Overview f Presentatin Intrductin; Suth African Exchange Cntrl fr Emigrants; What is a US Trust?; US Grantr Trusts and Freign Grantr Trusts; Sme General US Tax Principles; US Check-the-bx: General Principles; US Passive Freign Investment Cmpany (PFIC); US PFIC Example and Cmments n Example; SA/USA/DTA Tax treatment f SA Trusts; DTA Example and Cmments n Example; Cnclusin n DTA Treatment f Distributins frm SA Trusts which are Grantr Trusts; Overall Cnclusin.

3 3 Sme US/SA Trust Tax Issues Overview f Presentatin Intrductin Accrding t US statistics, mre than immigrants in the USA are f Suth African rigin; Many were relatively affluent when they left, and therefre were r are beneficiaries f lcal and ffshre trusts; This presentatin is mainly directed at the trustees f Suth African trusts; As will becme apparent, there is an imprtant interactin between Suth African exchange cntrl laws applicable t trusts f emigrants, and US tax laws; There is als an imprtant interactin between US tax law applicable t individuals, Suth African tax law applicable t trusts, and the US/SA tax treaty.

4 4 Sme US/SA Trust Tax Issues fr SA Trustees Suth African Exchange Cntrl fr Emigrants Exchange cntrl restrictins nly recgnise three types f trusts fr emigrants: wn-asset trusts, blcked trusts, and deceased funder trusts: Own-asset trusts: the emigrant is deemed t wn the trust assets directly, and can therefre remit the incme and capital gains arising frm thse assets, utside f Suth Africa; Blcked trusts : n distributins are remittable t any emigrant but lcal distributins may be made; Deceased funder/funder trusts : distributins are freely remittable t emigrants as s-called legacies ; A special applicatin must be made fr wn-asset status, which is nt autmatically granted: US Grantr Trust status can impact n wn asset trust status and vice versa It is pssible t btain wn-asset status fr a beneficiary percentage, e.g. if there are 5 beneficiaries, then applicatin can be made fr them t be deemed t wn 20% each. This may help (r nt!) the US tax attributin psitin, fr trust wnership f a PIFC; Generally, restrictins are impsed by the FinSurv Department f the SARB in respect f all three f the abve categries f trusts if any beneficiary r the funder r funder is an emigrant, including: Majrity f trustees must always be Suth African residents; Trust Deeds may nt be amended withut SARB/FinSurv cnsent; In respect f blcked trusts, n distributins may be made t nn-residents withut prir apprval.

5 5 Sme US/SA Trust Tax Issues fr SA Trustees What is a US Trust? A trust is a US Trust if: US curt exercises primary supervisin ver trust administratin; and US persns cntrl all substantial decisins f the trust. A Freign Trust fr US purpses is any trust that is nt a US trust; A trust with US gverning law, US trustees, US assets and US beneficiaries can be a freign trust with a nn-us prtectr (if a nn-us Prtectr cntrls sme r all f the substantial decisins). Taxatin f US Trusts? The taxatin f a US Trust is primarily dependent n whether the trust is a Grantr r a Nn-Grantr Trust but is als dependent n whether the trust is a US Grantr Trust r a Freign Grantr Trust; Of mst relevance fr SA emigrants t the USA, is a Freign Grantr Trust, which is generally regarded as beneficial. Why?

6 6 Sme US/SA Trust Tax Issues fr SA Trustees US Grantr Trusts US r freign trust which is disregarded ( fiscally transparent ) fr US incme tax purpses; Grantr is cnsidered t wn the prperty held by the trust; Incme, gains, lsses, deductins, all fr the Grantr, nt the trust; Wh is the Grantr? Varius tests: funder; funder; spuse f funder r funder, if the incme can be distributed t him withut the cnsent f an adverse party (sectin 677); Sectin 679: immigrants t US will be treated as Grantr f a freign trust if funded within five years f becming resident; Varius ther cmplicated rules; Pre-immigratin Grantr Trusts are primarily set up fr US estate duty (40%) planning and fr US gift tax (35%) planning; Additinal benefit: nrmal US tax treatment fr the emigrant (US Grantr) if PFIC rules d nt apply.

7 7 Sme US/SA Trust Tax Issues fr SA Trustees Freign Grantr Trusts A nn-resident Grantr (fr US tax purpses) is nt treated as the wner f a trust unless: The Grantr retains the pwer t revke the trust; r Distributins may be made nly t the Grantr r his/her spuse during the Grantr s lifetime; this may be determined by the trust deed; r this may be determined by applying a facts and circumstances test. Taxatin f Freign Grantr Trust? Glbal incme and gains are taxed directly t the Grantr; Trust itself is nly taxable n incme frm a US surce; Distributins can be made t ther US beneficiaries free f tax in the US, subject t certain cnditins/restrictins. Freign Nn-Grantr Trust? Trust nly taxable n incme frm US surce; But, undistributed incme is subject t interest charges s that verall US tax cst culd even equal the distributin; Freign nn-grantr Trust is therefre nt US tax efficient.

8 8 Sme US/SA Trust Tax Issues fr SA Trustees Sme General US Tax Principles Ordinary individuals incme tax prgressive tax rates: up t 39.6% fr 2011 nwards; Freign dividends tax rate: 15% (until December 31, 2012); Freign capital gains tax rate: 15% (until December 31,2012 certain gains up t 20%); State taxes are paid additinally t the abve; All Suth African discretinary and vesting trusts are lk thrugh fr purpses f determining US CFC and US PFIC status, as well as fr purpses f US tax credits, etc.

9 9 Sme US/SA Trust Tax Issues fr SA Trustees US Check-the-bx: General Principles Entity t nn-entity electin (and vice versa); Electin changes the US tax treatment f the freign cmpany; Benefits f making the electin: Enables flw-thrugh f freign cmpany tax credits (e.g. cmpany t partnerships); Uplifts the cst basis f shares fr CGT; Eliminates the applicatin f anti-deferral rules under the CFC r PFIC regimes; Prblems fr freign cmpanies? Yes, many, e.g. year-end mis-matches.

10 10 Sme US/SA Trust Tax Issues fr SA Trustees US Check-the-bx: General Principles, cnt. Cmplicated fr cmpanies held by trusts: need t understand bth US trust tax rules, and the US PFIC rules; The electin results in a deemed liquidatin f the Suth African cmpany resulting in a capital gain trapped in the wnership trust, and unless amunt equal t the gain is distributed in full in same year (US tax year), it is recharacterised as rdinary incme. The same excess rule as fr a PFIC then applies in any subsequent year; Earnings/prfits becme accumulated incme in the trust if nt distributed in the same tax year; Imprtant t first determine if a cmpany/entity is a US PFIC, then decide whether an electin must be made in respect f such PFIC fr the abve benefits.

11 11 Sme US/SA Trust Tax Issues fr SA Trustees US Passive Freign Investment Cmpany (PFIC) There are three alternate taxing regimes which are applicable t PFICs; First regime: Qualified Electing Fund: The relevant cmpany is required t make financial disclsures n an annual basis; r Secnd regime: Mark-t-Market: This regime is nly available fr public cmpanies; r Third regime: Excess Distributin and Interest Charge: This regime is triggered by a distributin r dispsal f an interest; An excess distributin is a distributin exceeding 125% f the average distributin fr the last three years; The entire gain derived upn a dispsal is deemed t be an excess distributin; It is the third regime which can be detrimental t trust beneficiaries and must therefre be avided.

12 12 Sme US/SA Trust Tax Issues fr SA Trustees US Passive Freign Investment Cmpany (PFIC) cnt. When is a cmpany a PFIC? Extremely cmplicated rules; Generally, when 75% r mre f a cmpany s grss incme is passive incme (e.g. dividends) r 50% r mre f the value f its assets are passive assets (e.g. shares in ther cmpanies), then it will be a PFIC; There is n minimum US wnership threshld but a lk-thrugh rule applies fr 25% r mre sharehlding; 125% 3-year average rule applies what is this? If a US taxpayer receives an amunt (dividend r capital gains), frm a PFIC that exceeds 125% f previus three year s average, the excess is characterised as rdinary incme and retractively taxed with interest charges ver the taxpayer s hlding perid. The balance is taxed as rdinary incme; Once a PFIC, always a PFIC (except fr a limited start-up exclusin); Prblems with certain types f incme e.g. rentals passive r active? Trust wnership is attributed t beneficiaries in prprtin t their interests. (What is a qualifiable prprtinate interest in a discretinary trust? All facts and circumstances are cnsidered).

13 13 Sme US/SA Trust Tax Issues fr SA Trustees US PFIC Example Emigrant US tax resident B 50% USA 50% A + B RSA Bank interest perating incme Nn-emigrant resident A SA C2 Opc 20% SA C1 Cntrller SA C3 SA C4 100% 100% 40% bank interest 100% Opc Opc SA C5 SA C6 25% passive investment incme Varius Invest c passive investments Opc Rental f ffice blck perating incme rental incme

14 14 Sme US/SA Trust Tax Issues fr SA Trustees Cmments n US PFIC Example SA trust is lk-thrugh fr US tax purpses, 50% deemed attributin t Persn B; SA C 2 is a passive investment f SA C 1 due t 25% rule nt being met, despite being an Opc, while all the ther cmpanies are active investments f SA C 1; Rental incme frm ffice blck fr SA C 4 wuld be a prblem in thery due t 25% rule; If actively managed by SA C 4, rentals are active incme; r If part f a syndicate/passive investment, rentals are passive incme; Passive incme f SA C 5 wuld ptentially be a prblem fr SA C 1, but active incme f SA C 6 culd cunter-act; Bank interest in SA C 1 is passive incme, as is divided incme frm SA C 2.

15 15 Sme US/SA Trust Tax Issues fr SA Trustees Cmments n US PFIC Example, cnt. Apply asset value test t SA C 1? under the 50% test, yu need t value all its active assets (SA C 3, SA C 4 (assume)), SA C 6, and then cmpare with the value f all passive assets (bank depsit in SA C 1, shares in SA C 2 and passive investment f SA C 5), then attribute 50% f the ttal t emigrant Beneficiary B; Or: Apply the incme test t SA C 1? passive incme is as fllws: bank interest, SA C 2 dividends, and SA C 5 passive incme. Active incme: all Opc s incme except SA C2. What if all the Opc s are making lsses? Apply n a grss incme basis and then attribute 50% t emigrant Beneficiary B; If nt a PFIC, based n the abve calculatins, 15% tax n current year distributed dividends. If a PFIC, 35% tax with n tax credits, unless a check-the-bx electin is made; If nt a PFIC, full US tax credits are available fr tax paid by the trust (but nt paid by the underlying cmpany).

16 16 Sme US/SA Trust Tax Issues fr SA Trustees Cmments n US PFIC Example, cnt. New Suth African dividends tax? 15% tax paid by the trust r by the cmpany? Withheld by C, levied n trust, s prbably creditable in the USA under bth DTA and US dmestic law. New SA Dividends Tax replaced STC wef 1 April 2012 and is withheld by the SA resident cmpany declaring the dividend. Hwever, the liability fr tax is that f the sharehlder; Des nt apply between SA-resident cmpanies, but des apply t all dividends declared t SA resident individuals and SA resident trusts at 15%; In the case f a SA vesting trust, flw-thrugh will apply and the beneficiary will suffer the tax liability; Dividends Tax rate is 15% but DTA relief culd apply in favur f nn-resident individuals (e.g. fr US residents, the 15% rate culd be reduced t 5%, depending n the sharehlder percentage, etc). Generally, US tax resident individuals will btain a US tax credit fr any Dividends Tax paid.

17 17 Sme US/SA Trust Tax Issues fr SA Trustees SA treatment vs. US treatment vs. DTA treatment Interactin between SA, USA and DTA tax principles is cmplicated in relatin t trust distributins t emigrant beneficiaries; In Suth Africa, discretinary trusts are taxed as fllws: Sectin 25B: Incme f trusts and beneficiaries f trusts flw thrugh, r nt; Paragraph 80: Capital gains attributed t beneficiary flw thrugh, r nt; Paragraphs 80(1) and 80(2) nly apply t distributins by resident trusts t resident beneficiaries, and nly where nne f the relevant tax-back r attributin rules apply. There are n specific prvisins which expressly apply t distributins by resident trusts t nn-resident beneficiaries. The s-called cnduit principle (which has been recgnised in case law) may be relevant in this regard; All f the abve nly applies t the extent that the sectin 7(8)/Para 72 attributin rules d nt apply t tax the dnr/funder/settlr. Vesting trusts are nt taxed and instead the vested beneficiaries are taxed in the current year.

18 18 Sme US/SA Trust Tax Issues fr SA Trustees SA treatment vs. US treatment vs. DTA treatment, cnt. The relevant prvisins f the US/SA DTA are the fllwing: Article 4 Residence 1. Fr the purpses f this Cnventin the term "resident f a Cntracting State" means: (d) in the case f an item f incme, prfit r gain derived thrugh an entity that is fiscally transparent under the laws f either Cntracting State, that incme shall be cnsidered t be derived by a resident f a State t the extent that the item is treated fr purpses f the taxatin law f such Cntracting State as the incme, prfit r gain f a resident (emphasis added). Article 13 Capital gains 5. Gains frm the alienatin f any prperty ther than that referred t in the preceding paragraphs shall be taxable nly in the Cntracting State f which the alienatr is a resident (emphasis added)."

19 19 Sme US/SA Trust Tax Issues fr SA Trustees SA treatment vs. US treatment vs. DTA treatment, cnt. Article 4 Residence Cmmentary (IRS Explanatry Memrandum) Cmmentary n Paragraph 1 f Article 4 Subparagraph (d) addresses special issues presented by fiscally transparent entities such as partnerships and certain estates and trusts. In general, subparagraph (d) relates t entities that are nt subject t tax at the entity level, as distinct frm entities that are subject t tax, but with respect t which tax may be relieved under an integrated system. This subparagraph applies t any resident f a Cntracting State wh is entitled t incme derived thrugh an entity that is treated as fiscally transparent under the laws f either Cntracting State. Entities falling under this descriptin in the United States wuld include Grantr Trusts. Subparagraph (d) prvides that an item f incme derived by such a fiscally transparent entity will be cnsidered t be derived by a resident f a Cntracting State if the resident is treated under the taxatin laws f the State where he is resident as deriving the item f incme (emphasis added).

20 20 Sme US/SA Trust Tax Issues fr SA Trustees SA treatment vs. US treatment vs. DTA treatment, cnt. Article 4 Residence Cmmentary (IRS Explanatry Memrandum) Cmmentary n Paragraph 1 f Article 4 cnt. The taxatin laws f a Cntracting State may treat an item f incme, prfit r gain as incme, prfit r gain f a resident f that State even if, under the taxatin laws f that State, the resident is nt subject t tax n that particular item f incme, prfit r gain These principles als apply t trusts t the extent that they are fiscally transparent in either Cntracting State (emphasis added).

21 21 Sme US/SA Trust Tax Issues fr SA Trustees SA treatment vs. US treatment vs. DTA treatment, cnt. Article 13 Cmmentary Cmmentary n Paragraph 5 f Article 13 Paragraph 5 grants t the State f residence f the alienatr the exclusive right t tax gains frm the alienatin f prperty ther than prperty referred t in paragraphs 1 thrugh 4. Fr example, gains derived frm shares may be taxed nly in the State f residence f the alienatr, t the extent such incme is nt therwise characterized as incme taxable under anther article (emphasis added).

22 22 Sme US/SA Trust Tax Issues fr SA Trustees SA treatment vs. US treatment vs. DTA treatment, cnt. Applicatin f the abve t SA trusts? 3 ptential scenaris: 1. Incme distributed t US resident beneficiary; 2. Asset (in specie) distributed t US resident beneficiary; 3. Capital gain distributed t US resident beneficiary. All three scenaris have very different tax treatment in respect f the incme and gains f a SA trust which has US Grantr Trust status; Trustees f such SA trusts must btain prfessinal tax advice prir t making any distributins t any US tax persns.

23 23 Sme US/SA Trust Tax Issues fr SA Trustees DTA Example Mr X US resident Mrs X US resident SA Trust SA tax resident trust 9% Cmpany A (UK) UK tax resident cmpany SA discretinary trust (SA Trust), which is tax resident in SA and is an wn-asset trust fr emigratin purpses, wns 9% f the shares in a freign cmpany (Cmpany A); SA Trust has tw emigrant, US resident beneficiaries, Mr and Mrs X; SA Trust is a US Grantr Trust in relatin t Mr X and an wn-asset trust fr SA exchange cntrl purpses in relatin t Mr X;

24 24 Sme US/SA Trust Tax Issues fr SA Trustees Example cnt. SA Trust wants t dispse f all the shares in Cmpany A and distribute the gain t Mr X; SA Trust has als received a dividend f R100 frm Cmpany A during May 2012 (2012 US tax year, 2013 SA tax year); The purchaser f the shares in Cmpany A is tax resident in Switzerland; The Trustees f the SA trust have three ptins: they culd dispse f the shares and then distribute the capital gain t Mr X; r they culd distribute the shares in specie t Mr X wh culd thereafter sell them himself; r they culd vest the shares in Mr X, and thereafter sell them.

25 25 Sme US/SA Trust Tax Issues fr SA Trustees Cmments n Example What is the tax treatment f the dividend received by SA Trust? The freign dividend received by SA Trust frm Cmpany A will nt be exempt frm SA incme tax under Sectin 10B as the sharehlding is belw 10%; If the trust retains the dividend, the trust itself will nrmally be taxable theren at 15%, while if it distributes the dividend in the current tax year, nrmally the resident beneficially will be taxable theren at 15%; In this case, as the SA Trust will be cnsidered a fiscally transparent entity fr US tax purpses under the US/SA DTA (because it is a Grantr Trust), Suth Africa will have n taxing rights, irrespective f whether the trustees distribute the dividend r nt. The dividend will therefre be subject t US tax in the hands f Mr X nly, at a US rate f 15% (until December 31, 2012).

26 26 Sme US/SA Trust Tax Issues fr SA Trustees Cmments n Example, cnt. What is the tax treatment f the sale f shares in Cmpany A by SA Trust? The Para 64B CGT exemptin will nt apply as the sharehlding in Cmpany A is belw the qualifying threshld f 10%; Therefre, SA Trust wuld nrmally be liable fr CGT at an effective rate f 26.7% (if the trust retains the gain) r the beneficiary will be taxable at 13.3% (if a resident wh is a natural persn); Hwever, Mr X is subject t tax nly in the US n the capital gain derived, because f the fact that SA Trust is fiscally transparent (by virtue f being a Grantr Trust), as under article 13(5) f the US/SA DTA, Mr X will be deemed t be the alienatr f the shares (n DTA tax credit required); This SA tax psitin applies irrespective f whether the trustees distribute the capital gain t Mr X in the same tax year, r in a subsequent tax year, while if the distributin is made in a subsequent tax year, certain negative US tax implicatins will arise.

27 27 Sme US/SA Trust Tax Issues fr SA Trustees Cmments n Example, cnt. What is the tax treatment f the vesting r distributin f shares in specie t Mr X, whereafter Mr X dispses f the shares? In Suth African trust law, an asset f a discretinary trust can be vested in a discretinary beneficiary, withut actually distributing such asset in specie t such beneficiary. The trustees retain cntrl ver such asset, but full ecnmic value resides in the beneficiary; In effect, vesting creates a new trust, referred t as a bewind trust, which is a Rman- Dutch creatin; Suth African CGT is payable upn vesting r upn a distributin f assets in specie, as bth types f events are deemed dispsals fr CGT purpses; SA Trust is therefre liable fr CGT at a rate f 26.7% upn the vesting f the asset, r the distributin f the asset in specie, as bth events are deemed dispsals fr Suth African CGT purpses. N DTA relief, as the dispsal is made by a fiscally transparent entity t a beneficiary theref (i.e. fr US tax purpses, Mr X is dispsing f an asset t himself). There will be a CGT liability in the US later, in respect f the subsequent sale by Mr X t the Swiss resident;

28 28 Sme US/SA Trust Tax Issues fr SA Trustees Cmments n Example, cnt. The result is that bth SA CGT at 26.7% and later US CGT at 15% (r 20%) will be payable; Will the US resident (emigrant beneficiary) receive a US tax credit? Definitely nt under the US/SA DTA, as the SA deemed capital gain is nt treated as a taxable capital gain in the hands f Mr X; Hwever, Mr X culd ptentially claim a tax credit nt under the US/SA DTA, but under US dmestic tax law. Even thugh he may make an electin t claim a US tax credit n an accrual basis, it is dubtful whether this electin can be used in this case as fr Suth African tax purpses the trust is nt tax transparent (fr this transactin), and therefre a different entity is being taxed n a different gain; If n US tax credit under US dmestic law, this is therefre a classic example f ecnmic duble taxatin in respect f which ptentially n duble tax relief is available.

29 29 Sme US/SA Trust Tax Issues fr SA Trustees Cnclusin n US/SA DTA Treatment f distributins frm SA Trusts which are Grantr Trusts Distributin f current incme t a US resident: cnduit principle cupled with DTA fiscal transparency treatment causes it t be taxable nly in the USA; Distributin f a current capital gain t a US resident: accrding t SARS view, taxable in SA trust under SA dmestic tax law (26.7%) but taxable nly in the USA if the USA/SA DTA applies (DTA relief); Capitalisatin f a capital gain in the trust: nrmally SA CGT at 26.7% but verridden by DTA if the US/SA DTA applies because Mr X is instead taxable n this gain in the USA. Subsequent distributins will, hwever, have negative US tax cnsequences fr Mr X s distributin f all current year gains is preferable; Distributin f asset in specie t a US resident r vesting f asset: taxable in trust at 26.7% (SA tax) and n US tax cnsequence (distributin t yurself but later sale will cause US CGT with n DTA credit fr SA trust tax under the DTA (therefre ecnmic duble taxatin)). Hwever, ptentially arguable that later credit in US fr prir SA tax paid, e.g if accrual electin is made (under US dmestic law).

30 30 Sme US/SA Trust Tax Issues fr SA Trustees Overall Cnclusin US tax treatment f SA trusts gives bth benefits and prblems; Clear interactin between US Grantr Trust status, and exchange cntrl wn-asset trust status; US Grantr Trust status may assist in btaining wn asset trust status frm SARB and vice versa; US tax issues may require SA trustees t make distributins f all current year incme and gains in certain cases; Selectin/decisin by Suth African trustees abut whether and when t distribute incme, gains r assets must be dne having regard t US tax and DTA principles, as cnsequences may materially differ!

31 QUESTIONS? 31

32 Presenter s cntact Details 32 Prfessr Michael Hniball Partner, Webber Wentzel Tel: Fax: michael.hniball@webberwentzel.cm Websites:

33 33 Sme Recmmended US Advisrs Peter Rsenberg TerraNva Services, LLC 1900 Market Street Philadelphia PA T Jerry Gumpel Sheppard Mullin Richter & Hamptn LLP El Camin Real Suite 200 San Dieg, CA T Christpher Uzpen Withers Bergman LLP 157 Church Street New Haven, Cnnecticut T Legal Ntice: these materials are fr training purpses nly and d nt cnstitute legal r ther prfessinal advice.

34 34 BOTSWANA BURUNDI ETHIOPIA KENYA MALAWI MAURITIUS MOZAMBIQUE RWANDA SOUTH AFRICA TANZANIA UGANDA ZAMBIA JOHANNESBURG 10, 16 & 18 Fricker Rad, Illv Bulevard, Jhannesburg, 2196, Suth Africa PO Bx 61771, Marshalltwn, Jhannesburg, 2107, Suth Africa T CAPE TOWN 15 th flr, Cnventin Twer, Heerengracht, Freshre, Cape Twn, 8001, Suth Africa PO Bx 3667, Cape Twn, 8000, Suth Africa T Legal Ntice: these materials are fr training purpses nly and d nt cnstitute legal r ther prfessinal advice.