The tax implications of a typical holding company structure with the use of a trust

Introduction

In this issue we take a look at the tax implications of a typical holding company structure that involves the use of a trust at the top of the structure as a tool to extract profits and protect investments.

The benefits

The creation of a holding company structure allows central management and control over the subsidiaries. If one of the subsidiaries suffers reputational damage, becomes insolvent, or cannot operate for any given reason, the other subsidiaries in the group will operate without interruption. The holding company can also play the role of being an inter - group bank as the books of the holding company will reflect the subsidiaries and in turn a larger book of assets which make it a more favourable borrower in the eyes of a lending institution.

The trust at the top of the structure will provide a vessel to conduct the business of the group and it will also provide a mechanism to extract profits for the benefit of the beneficiaries.

The structure

The hypothetical structure is as follows –

• A holding company that holds all the shares in certain subsidiary companies (“HoldCo”), with HoldCo not conducting any business;
• A trust that owns all the shares in HoldCo ("the Trust”); and
• HoldCo declares all dividends earned from the subsidiaries to the Trust.

Assumptions 

The hypothetical set of facts includes the following assumptions:

• The transactions transferring the shares to HoldCo and the Trust have been implemented and there are no adverse tax consequences that need to be considered, including the requirement that the holding company be an “operating company” as defined in section 24O of the Income Tax Act 58 of 1962 (“ITA”).
• The beneficiaries of the Trust are natural persons, as it the position with most trusts.
• All dividends to be paid to HoldCo and to the Trust are “dividends” as defined in section 1 of the ITA and thus do not constitute dividends in specie. 
• All dividends declared by both the subsidiaries and HoldCo are declared and paid on the same date. This is because for dividends tax purposes, the date on which a dividend is paid suffices for the imposition of dividends tax. This gives clarity on when and who is liable to pay the dividends tax.
• All companies are private companies and are all tax resident within the Republic of South Africa.
•  We are only concerned with corporate income taxes and as such we do not address employees’ tax or value-added tax. 

Tax implications 

The dividend from the subsidiaries to HoldCo

1. The declaration of dividends from the subsidiaries to HoldCo are exempt from income tax in terms of section 10(1)(k)(i) of the ITA. Therefore, HoldCo is not liable for income tax on declaration from the subsidiaries or upon receipt of the dividends.
2. The declaration of dividends from the subsidiaries to HoldCo are exempt from dividends tax in terms of section 64F(1)(a) of the ITA.
3. In effect, the dividend will be tax free at the level from the subsidiaries to HoldCo.

The declaration of dividends from HoldCo to the Trust

Depending on the provisions of the trust deed and the type of trust, there are a number of tax consequences to consider. We consider the tax implications of both a bewind trust and that of a discretionary trust.

Should the trust be a bewind trust:

1. The dividends declared by HoldCo, flowing from the subsidiaries, are in effect a declaration of a dividend to the beneficiary in terms of section 64D read with section 25B (1) of the ITA. This is not per se the application of the flow-through principle because the beneficiaries own the shares declaring the dividends. Instead, section 25B (1) applies to the extent that the trustee is exercising fiduciary control over HoldCo.
2. Since it is the beneficiary who is the “beneficial owner” of the dividend, that is the person who is entitled to the enjoyment of the dividends that are attached to the share, the beneficiary will be liable for the dividends tax of 20% in terms of section 64E(1)(a) (i) read with section 64EA (a) of the ITA. 
3. Furthermore, although it is the beneficiary who will be liable for the dividends tax, HoldCo bears the obligation to withhold the dividends tax in terms of section 64G (1) of the ITA. 

Should the Trust be a vesting trust:

Where the rights to the dividends are vested in the beneficiaries of the Trust, the tax consequences as described for a bewind trust shall equally apply.

Should the Trust be a discretionary trust:

Where the trustee(s) exercise their discretionary powers to distribute the dividends to the beneficiaries in the same year of assessment that the dividend is received by the Trust:

1.  HoldCo is in effect declaring a dividend to the beneficiary in terms of the deeming provisions of sections 25B (1) & (2) of the ITA. The beneficiary is deemed to be the beneficial owner of the dividend and the beneficiary will be liable for the dividends tax of 20% in terms of section 64E (1)(a)(i), read with section 64EA (a) of the ITA. However, as a matter of timing, the Trust would be liable for the payment of the dividend tax for the period the dividend has not been distributed to the beneficiary. This is however academic as HoldCo would in any case pay the dividends tax since it withholds it on the date of payment. All of these mechanisms are simply put in place so that the South African Revenue Service (“SARS”) can always hold someone liable for its tax. In terms of section 64K (1)(a) the tax must be paid by the last day of the month following the month during which HoldCo pays that dividend. Should the HoldCo not pay the dividends tax within this specified time and the Trust has not distributed this dividend to the beneficiary, it is the Trust that will be held liable for the tax, unless the beneficiary pays the tax.
2.  HoldCo is required to withhold the dividends tax in terms of section 64G(1) of the ITA. 

Should the Trust be a discretionary trust: 

Where the trustee(s) do not exercise their discretionary powers to distribute the dividends to the beneficiaries in the same year of assessment that the dividend is received by the Trust, but instead elect to retain the dividend receipt in the Trust:

1. The declaration of dividends from HoldCo to the trust is exempt from normal tax in terms of section 10(1)((k)(i) of the ITA because the Trust is a “person” as defined in section 1 of the ITA. 
2. Since the beneficiary does not become the beneficial owner of the dividends during the year of assessment, the Trust is the beneficial owner and will be liable for dividends tax of 20% as it does not enjoy the exemptions provided for under section 64F of the ITA.
3.  Furthermore, although it is the Trust that will be liable for the dividends tax, it is HoldCo that will be required to withhold the dividends tax in terms of section 64G(1) of the ITA. 
4. Should the Trust elect to later pay an amount to the beneficiary in a subsequent year of assessment, although tax had already been paid on the dividend it has now lost its character as a dividend and the beneficiary will be taxed at the applicable marginal rate of income tax (depending on the amount of income that is distributed to the beneficiary in that subsequent year of assessment).

Comment 

The structure and the tax implications described above should not be used as tax advice as this is a hypothetical set of facts. Each transaction in a real scenario has its own distinct challenges and will never be as straightforward as what has been described in this article. Should you need advice on tax related matters, contact our offices to arrange for a consult. 

Mabhelandile Ntuli Attorneys are registered tax practitioners who provide assistance on a range of tax matters. We approach tax and legal issues with certainty.