Commissioner for the South African Revenue Service v The Thistle Trust

The Thistle Trust was a beneficiary of ten vesting trusts (Tier 1 Trusts) comprising the Zenprop Group, which conducted property ownership and development business. During the 2014, 2015 and 2016 tax periods, the Tier 1 Trusts disposed of certain capital assets and realized capital gains. These capital gains were distributed to the Thistle Trust in the same tax periods. The Thistle Trust, in turn, distributed the amounts received to its beneficiaries in the same tax periods. The Thistle Trust treated the proceeds received as taxable in the hands of its beneficiaries. SARS raised an additional assessment dated 21 September 2018 for the periods 2014, 2015 and 2016, taxing the amounts received by the Thistle Trust as taxable in its hands, and imposed an understatement penalty of 50% and interest. The Thistle Trust objected, arguing that under section 25B of the ITA and paragraph 80(2) of the Eighth Schedule, the capital gains ought not to have been taxed in its hands but in the hands of its beneficiaries. The objection was disallowed by SARS. The Tax Court upheld the Thistle Trust's appeal and set aside the additional assessments. SARS appealed to the Supreme Court of Appeal with leave.

• Whether capital gains accrued as a result of the disposal of capital assets by the Tier 1 Trusts are taxable in the hands of the Thistle Trust or in the hands of the beneficiaries of the Thistle Trust to whom those gains were distributed
• Whether section 25B of the Income Tax Act 58 of 1962 or paragraph 80(2) of the Eighth Schedule applies to the taxation of capital gains distributed through successive trusts
• Whether the 'conduit-pipe principle' applies to allow capital gains to flow through the Thistle Trust untaxed
• Whether the circumstances warranted the imposition of an understatement penalty of 50%
• Whether SARS was entitled to levy interest on the assessed liability

The appeal succeeded with costs. The order of the Tax Court, Gauteng, was set aside and replaced with the following order: (a) The appeal is upheld only to the extent that the understatement penalty is set aside; (b) There is no order as to costs.

Section 25B of the Income Tax Act 58 of 1962 applies to the taxation of income that accrues to trusts or their beneficiaries, and does not apply to capital gains. The Eighth Schedule to the ITA provides a self-contained method for determining capital gains taxation. Paragraph 80(2) of the Eighth Schedule applies where a trust determines a capital gain in respect of the disposal of an asset and a beneficiary of that trust acquires a vested right to an amount derived from that capital gain but not to the asset disposed of. In such circumstances, the capital gain is taxable in the hands of the trust, not the beneficiary. Where a trust receives capital gains as a vested right from another trust and subsequently distributes those gains to its beneficiaries without itself disposing of a capital asset or determining a capital gain, the capital gains remain taxable in the hands of the receiving trust. The 'conduit-pipe principle' does not apply in such circumstances because the trust received the gains as of right and did not dispose of capital assets. An understatement penalty under the Tax Administration Act 28 of 2011 is not payable where the understatement results from a bona fide inadvertent error, even where the taxpayer relied on legal advice in adopting an incorrect tax position.

The Court noted with approval the statement in Milnerton Estate Ltd v CSARS that the Eighth Schedule 'seems to provide a self-contained method for determining whether a capital gain or loss has arisen'. The Court also referred to the caution expressed by Trollip JA in Secretary for Inland Revenue v Rosen that while the conduit-pipe principle is applicable for general application in the South African tax system, it ought only to be applied in appropriate circumstances to be determined on a case-by-case basis. The Court observed that the insertion of the phrase 'other than an amount of a capital nature which is not included in gross income' into section 25B(1) after the introduction of capital gains tax in 2001 (when section 25B had been in existence since 1991) was 'yet another indicator that this section does not apply to an amount of the nature of a capital gains'. The Court also noted that section 25B(3) provides insight into the amount contemplated by the section, indicating that it was 'the taxable income derived by way of any amount', demonstrating that the section deals with taxable income and not capital gains.

This case is significant in South African tax law as it clarifies the relationship between section 25B of the Income Tax Act 58 of 1962 and paragraph 80(2) of the Eighth Schedule in the context of capital gains taxation of trusts. It establishes that section 25B applies only to income of a revenue nature and not to capital gains, which are dealt with exclusively in the Eighth Schedule. The judgment provides important guidance on the application of paragraph 80(2), particularly in scenarios involving successive trusts where capital gains are distributed. It clarifies that when a trust (as opposed to a capital asset) vests capital gains in a beneficiary trust, and the beneficiary trust subsequently distributes those gains to its own beneficiaries without itself disposing of a capital asset, paragraph 80(2) does not operate to make the gains taxable in the hands of the ultimate beneficiaries. The case also limits the application of the 'conduit-pipe principle' in the context of capital gains tax, confirming that the principle does not apply where a trust receives capital gains as of right and then distributes those gains, rather than disposing of capital assets. Additionally, the judgment reinforces the principle under section 222(1) of the Tax Administration Act that understatement penalties are not payable where the understatement results from a bona fide inadvertent error, even where a taxpayer has taken an incorrect tax position based on legal advice.